Banks’ pass mark will create confidence but do little to source cash

The two big Irish banks passed the much-awaited EU-wide stress tests of 91 banks but hardly came top of the class compared with some of their European peers.

Given the crisis that Irish banks have endured, a pass will create some confidence among debt investors but it may not do much – in the short term anyway – when it comes to raising funding without the crutch of the State guarantee.

Still, the higher cost facing the Irish banks for their funding – as the test confirms they are riskier than others – may tempt investors seeking higher returns. This is particularly significant with the crucial September 29th refinancing date – marking the end of the blanket guarantee – approaching. The two banks did, however, fall well below the aggregate level of capital after the test was applied to institutions across 20 countries.

A tier-one capital ratio of 6 per cent was set as the pass mark.

After the health check, they were required to have capital equal to 6 per cent of assets (essentially loans) – so, for every €100 they had in loans, they would have to show €6 in reserve after the stress-case scenario was applied. AIB had 7.4 per cent after the test, while Bank of Ireland fared better at 7.8 per cent.

However, the Financial Regulator’s own stress test earlier this year was more aggressive so the tests also included the regulator’s expected losses on Nama and non-Nama property loans at the banks.

Ireland’s problem is after all more about property than sovereign debt. After these losses were included, AIB had a 6.5 per cent ratio while Bank of Ireland again fared better, with 7.1 per cent. The Committee of European Banking Supervisors (CEBS) found that the 91 banks emerged with an aggregate ratio of 9.2 per cent after the test, which ranked Ireland as the third riskiest sovereign debt behind Greece and Portugal under worst-case scenarios based on factors including the stresses experienced last May.

One Spanish lender, Banca March in Mallorca, was the best protected, emerging with a capital to assets ratio of 19 per cent, while the weakest, Diada, the Spanish savings bank, had just 3.9 per cent. AIB faced losses of €666 million and Bank of Ireland €591 million on government bonds under the “what-if” drill involving a sovereign debt shock across Europe. The results of course assume that AIB will raise the capital target of €7.4 billion set by the regulator. Given that this will come from investors or Government, AIB was deemed to have passed. Minister for Finance Brian Lenihan followed the results with a statement saying the Government or international investment banks would underwrite AIB’s efforts to raise capital after it sells its Polish, US and UK businesses. Any capital shortfall existing after the sale of these businesses will be met by investors or the Government.

The level to which the Government stake will rise rests on the price AIB gets for those assets and the bank’s ability to tap investors. Both Irish banks face further tests – raising funding without the guarantee and, for AIB, capital in a market that is still highly volatile.