Thursday, December 15, 2011

Stress Test Pain

There is substantial evidence that last week's European Banking Authority stress tests are squeezing banks' business instead of making them safer. Let's consider Spain's Banco Stantander, which has the largest reserve deficit in Europe at €15bn.

Spain just sold a chunk of its Chilean subsidiary for about €800mn. Though they still have a 67% stake, this is not a disposal of a superfluous investment, like the auto parts company that holds equity in a computer chip manufacturer. This is Santander's core businesses! And Santander Chile is one of the best parts of its business. It's a cash cow in a growing and stable foreign market. Its ROE over the last 9 months was 24%, one of the highest returns in the Chilean financial system. The sale valued the whole subsidiary at about US $10bn, down from $13bn in the summer. In summary, a distressed sale in a down market - the kind of transactions that erode shareholder value and make it harder for the bank to finance other activities.

Perhaps this is a game of high-stakes chicken. The EBA challenged banks to boost capital ratios by foregoing dividends and soliciting fresh contributions from shareholders. The banks have taken a left turn by selling assets, shooting themselves in the foot but calling into question the stress test system itself.

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