EU Banks Sovereign Debt Mystery Deepens

Just when you thought it was safe to trust European banks again, the Wall Street Journal analyzed recent EU bank stress tests and found that a number of banks underreported their sovereign debt liabilities. Many investors, and EU regulators, were hoping to put the Greek debt crisis in firmly in the rear view mirror, but given the spotty nature of the bank’s disclosures, this may heighten concerns, rather than put them to rest.

Reading the WSJ article, I guess I shouldn’t be surprised about the various tricks the banks got up to in an effort to avoid or evade disclosing their sovereign debt holdings, but I was. As a student of accounting, it seems to me that the terms “net” and “gross” when it comes to overall exposure to sovereign debt is pretty clear, but apparently not. Among other “omissions,” the WSJ reported that:

• Barclays PLC excluded a bunch of sovereign bonds it held for trading purposes.
• France’s Crédit Agricole SA excluded sovereign debt held by it’s insurance unit.

The Committee of European Banking Supervisors (CEB), a London-based organization that provides advice to the EU on banking issues, conducted the tests and released the results on July 23. At the time the results were released, they were generally viewed as positive, but this WSJ analysis casts doubt not only on how much shaky European debt European banks are holding but also how transparent the entire “stress test” process actually is.

So what do these tests actually mean in terms of sovereign debt, if it’s impossible to know exactly how much sovereign debt EU banks hold on their balance sheets? Basically, not much. And not only are we not really sure how much debt these banks have on their books, the figures reported by the banks in the stress tests differ wildly from other international reports of such debt—including the Bank of International Settlements—and are, in many cases, impossible to reconcile with the banks own balance sheets.

So down the road, if there’s another European sovereign debt crisis or the markets just get twitchy about some of the EU’s weaker members, including the PIIGS (Portugal, Italy, Ireland, Greece and Spain), and the sovereign debt markets experience problems again, EU banks may be hit hard where it counts, in the balance sheet. But we don’t exactly know what the impact would be of further downgrades of sovereign debt, because we’re not sure just how much of it the banks are carrying on their books.

This is potentially dangerous, and could mean that European banks are weaker than previously thought. If these stress tests were just so much window dressing, even in this one area, a further sovereign debt crisis could create a crisis of confidence in European banks, which could virally spread across the globe, much like the Wall Street crisis of 2008. Time will tell.

–Amy E. Buttell is a journalist working in Erie, Pennsylvania and is a graduate of Mercyhurst College with a certificate in accounting.