EBA stress test rating implications to be limited, says Moody’s

The European Banking Authority's (EBA) stress test of European banks is likely to have limited rating implications and should have a variety of positive effects for banks, Moody's Investors Service said Wednesday.
As Moody's ratings already incorporate its own stress-testing exercises, the rating agency anticipates that the EBA stress test results will mostly reveal weaknesses that are already captured in Moody's ratings. The agency said it will respond accordingly in any case where the results reveal weaknesses that are not already reflected in the ratings.
Moody's views positively the EBA's statement that for those banks failing the EBA stress test, support measures will be announced. Such support measures may contribute to strengthening these bank's credit profiles and possibly their stand-alone ratings.
Of the 91 EU banks subject to the EBA's 2011 stress test, Moody's believes that 26 rated banks have a heightened risk of needing extraordinary external support, as indicated by their non-investment-grade standalone credit strength (standalone bank financial strength ratings at or below D+, mapping to Ba1 on the traditional rating scale).
The rating agency said it expects the banks that fail the EBA stress test will be among those lower-rated banks, or among the non-rated banks.
“Even if the EBA's stress test does not achieve all of its objectives, it should have a variety of positive effects for banks. These include (i) the test having already prompted several banks to strengthen their capital positions pro-actively; (ii) an improvement in transparency that will result from the planned disclosure of banks' sovereign exposures; and (iii) insight into regulators' assessment of banks' capital positions,” Moody’s said.
Whether the publication of test results scheduled for July 2011 will positively affect banks' access to financial markets partly hinges on market participants viewing the tests as credible. The EBA's 2011 stress test will incorporate additional measures of sovereign stress aimed at reflecting recent market developments, which is a step that enhances the credibility of the exercise. However, whilst the 2011 stress test is stricter than the 2010 European bank stress test, Moody's noted that the EBA's 2011 stress assumptions do not assume a sovereign default at a time when the risk of a sovereign default within the euro area has increased.
Stress-testing is increasingly used by regulators, banks and other stakeholders to assess banks' soundness under a range of conditions, which can be particularly valuable in an unstable environment. Stress tests are particularly helpful for banks and the official sector in assessing the need for remedial action in respect of weaker banks.