Stress Testing Irish Banks

[bungaloid]

In a recent interview John Hurley of the Central Bank has emphasised that the Irish Banking system is sound. How does he know? Stress-testing. CB has stress-tested the banks and they look OK. Results available later.

‘We stress test the banks’ lending and while the most recent results of that **won’t be available for some months **the early indications are that the banking system is surviving the turmoil well,’ Mr Hurley said.

rte.ie/business/2008/0710/centralbank.html

What is stress testing? Allan Kearns of the CB has a paper which explains the methodology in detail as part of the 2006 Financial Stability Report.

centralbank.ie/data/FinStaRe … esults.pdf

He looks at banks exposure to credit, liquidity, fx, rates and equity. Liquidity took down Northern Rock, for example. I want to look at just the property related risk - credit.

Credit stress-testing involves two parameters - NPA = % of non-performing loans or assets and LGD = % Loss given default. In 2006 NPAs were just under 1%. A combination of high NPA and high LGD destroys a banks capital adequacy ratio and takes it down.
You can approximate LGD by how much property prices fall (bank forecloses and sells at a loss). Of course in a state of the world where house prices have fallen say 50%, the NPA number increases as well. More people just walk away.

On p 4 of the paper Kearns says:

No institutions capital ratio falls below the regulatory minimum of 8% when NPAs double and there is an LGD rate of 25%. However this begins to occur when LGD is higher than 25% or NPAs more than double.

Now since the 2006 Financial stability report banks have been hit by liquidity, fx, interest rates and an equity crash. House prices have fallen a minimum 20% and show no sign of stopping there. Yet the threshold for property price falls to cause banking problems was only 25% in 2006.

The central banks published stress testing methodology seems to imply that we have already crossed the threshold where banks need to raise capital or worse.

[CaveCanem]

the main risk is construction and development debt. There’s over 100bn. This will have higher loss given default (whose going to buy a distressed field and who’ll provide the loan now?).

Question is if the interest rolls up, is there any way of telling that it isn’t performing? Any loan where interest is capitalised should attract a higher charge.

[Gilroy]

From the bottom of Page 101

As noted in the introduction, the approach adopted throughout all the tests documented in this paper is that all losses are immediately written off against capital under a conservative assumption that no profits or other reserves are available to cover the losses.

Its a nice find Bungaloid, and I’d love to see the bank specific analysis behind creating the aggregate figures. Just one point…the assumption above seems quite conservative and the banks are still showing profits and paying dividends (rightly or wrongly is a different thread).

Should we not expect to see profits wiped out before the raising of capital and if this is going to be the long drawn out affair as expected should we not get pretty ample warning?

[bungaloid]

By refinancing bad loans or otherwise massaging NPA numbers, a bank can pretend that LGD numbers are low as well. Roll the loan over, no default, then there is no “loss” right?

It is impossible to believe that true NPAs are not 2% or more, and that LGDs are not 25% or more. That puts us well within the regime where some banks need to recapitalise according to the CBs own stress testing of 2006.

Now the central bank is telling us all is well, don’t worry, our stress testing says everyone is OK, banks won’t need capital.

How is that possible? I am sorry to be so fucking stupid, but how is that now possible?

I have seriously lost confidence in financial regulation in this country.

[Dreaded_Estate]

‘We stress test the banks’ lending and while the most recent results of that won’t be available for some months the early indications are that the banking system is surviving the turmoil well,’ Mr Hurley said.

What does that mean? Surely they either are or are not surving the crisis.
Where is the grey area?

[Maine08]

‘We stress test the banks’ lending and while the most recent results of that won’t be available for some months the early indications are that the banking system is surviving the turmoil

well,’ Mr Hurley said.

What does that mean? Surely they either are or are not surving the crisis.
Where is the grey area?

Mr Hurley just wants to do a Greenspan…exit the room for pension just before the fan get obliterated.

In fairness Hurley did make some comments about the madness but took not even a distant relation to the type of action that was required.

[townes]

‘We stress test the banks’ lending and while the most recent results of that **won’t be available for some months **

the early indications are that the banking system is surviving the turmoil well,’ Mr Hurley said.
rte.ie/business/2008/0710/centralbank.html

He looks at banks exposure to credit, liquidity, fx, rates and equity.

What I don’t undertsand is this…
There are five measures they look at, as noted. Individual bank prepared reports with regard to liquidity, fx and rates (which are detailed reports) take, at most, a few days to thoroughly review. The credit and equity reports will take longer - as individual loans etc will need to be examined - but 10 days should cover that. To assist in these times, one would expect, in any event, that the Central Bank has moved more analysts, assistants into this review area.

So, why is Hurley saying it takes “some months”. Typical public servant approach, I suggest. Such a review by a private sector group would be completed within a couple of weeks.

[bungaloid]

I agree townes, why the delay? what are they waiting for, armageddon?

The CB say that the market is acting irrationally. In fact it is the CB who are acting irrationally. They appear to be in denial about the implications of their own analysis. The market is reflecting what the central banks own stress testing analysis shows - banks need to raise capital.

The only question to me is, will banks succeed in raising the capital they need? Where is the cash going to come from? Depositors?