Crunch week for Europe as new bank stress tests to be unveiled

Here’s a personal snippet. I have never failed an academic exam in my life. Failed a driving test and separately, a motorcycle test, though, each only once before passing the second time. But academically the record is 100%. I came very close once to failing a tax exam. It was not a subject I took to and it was never going to be central to my career, and the rules, laws, exceptions and even principles were very difficult for me to absorb. And on the day of the exam itself, I sat through the three hours and threw as much information at the answers as possible, hoping something would stick. Truth was, I didn’t understand the subject to the level required. It was one of four subjects examined over a couple of days and I had to wait three months to get the results. And on the day the results came out (by post – the internet was only in its infancy) – I picked the letter up from the door mat on the way out to work, didn’t open it because I feared the worst and it was only on the train platform waiting for the train that I summoned up the courage to grasp the nettle. And thinking about it now, opening exam results on a train platform is probably a very bad idea. But open it I did and looked down for the four subjects and four grades and looked for the “D” that would have indicated failure. It wasn’t there and it took seconds to grasp that I had gotten a “C” in tax, just enough to pass. And I could not believe it. It was a mistake surely. A few days after the exam results came out, the institution published its examiners’ report which reviewed overall the performance of all candidates, and I will forever remember the review of the tax exam – the standard demonstrated by students was abysmal, questions were unanswered, candidates gave a number of options for the answers and one just wrote a poem and left it at that! And the reason I deduced I had passed was that the institution apparently had a quota for passes -35-40% of candidates at that level and they adjusted the pass mark, up or down, to force the final result. And that’s how I passed taxation. Pretty grubby, when you think about it really.

But the episode is recalled now that the Europe is yet again to publish on Friday next, 15th July 2011, the results of stress tests on the main banks in Europe. Only two weeks ago, Reuters was reporting that the results would be published on Wednesday 13th July, but maybe those in charge concluded that mightn’t have been a good omen. It’s a pretty important event and there is quite a strict timetable for the release of information next Friday, as set out in the announcement here, by the body supervising the stress tests, the European Banking Authority (EBA). I wouldn’t blame you for glazing over at this point and ask who the hell the European Banking Authority is. It is the replacement body formed only eight months ago to take over the work of the Committee of European Banking Supervisors (CEBS). And again you ask, who the hell is/was the CEBS. The CEBS produced the first stress tests in July 2010, remember those? 91 banks were stress tested and seven failed, five of which were Spanish. And two Irish banks were tested, AIB and Bank of Ireland and both passed. And only a few months later, it was established that both banks needed €18.5bn to stay open. The total new capital requirement for banks assessed by CEBS last year was €3.5bn for all 91 banks.

Of course last July 2010, there was widespread derision of the results of the stress tests. A recurring criticism was that the stress tests did not take account of a default by a country in the EU which might then render worthless or less valuable bonds held by the subject banks. That is being remedied in these present stress tests, but already suspicion is understandably growing about how rigorous the stress tests will be. Reuters reported on 28th June 2011 that it has been pre-determined that 10-15 of the 91 banks were set to fail. Citing a “source”, Reuters wrote

“The EBA wants the number of banks that do not pass the tests to be around that level [10-15] to show the examinations were serious, said a second source, adding the authority did not want to push for more, for fear it could spark panic.

“In order to demonstrate that it is credible, the EBA would need to show that the number of bank failures is significant, without being substantial,” said the source. “A number in the teens is about right.”

Bloomberg also (separately) reported “The EBA may fail as many as 15 banks to give the lender examinations more credibility, a person familiar with the negotiations told Bloomberg News.”  This was subsequently denied by the EBA but given the fiasco of last year’s results, who would you believe?

Moody’s, the bete noire ratings agency – at least to Europeans after it downgraded Portugal’s credit status to junk during the week – is reported to have concluded that 26 out of the 91 banks will need additional capital support. The list of 26 shown here at zerohedge shows all three Irish banks needing more capital and shows six Spanish banks needing more capital. Moody’s are reported to have assessed the additional capital requirements of Spanish banks at €45-119bn. The view on here, which is based on very rough estimates of current loans and provisions, is that Spanish banks will need considerably more. Remember Spanish banks are understood to have €450bn of land and development loans which in Ireland required 60% write-downs when transferred to NAMA. Spain is understood to have 10% provisions for losses, meaning that if Spain’s property market were to go the way of Ireland’s, an additional €225bn of losses might be crystallized. Spain has so far weathered the property bust with only a 21% decline in residential prices from peak – compared to 41% in Ireland – but in Q1,2011 alone the decline in Spain was 4.7%, and take a look at the adverse scenario for 2011 for residential property for Spain above, minus 12.3% – that is looking low based on Q1,2011 results. So the results this week will be closely watched and may finally herald a conclusion toSpain’s pretendy bank health, which might in turn lead to a wider EU solution to over-indebted countries includingIreland.

And lastly, remember that most of the old CEBS board members who oversaw the widely discredited stress tests last year are now board members of the EBA. How safe will the stress tests results on Friday be? About as safe as a pillion passenger on my motorbike when I first took my test.

Stress tests 2011 – key documents and links

EBA announcement of stress tests – 18th March, 2011 here

EBA announcement of timetable for release of results of stress tests on Friday 15th July, 2011 is here

List of 91 banks being subjected to stress testing is here, and includes three from Ireland – AIB, Bank of Ireland and Irish Life and Permanent – and a staggering 25 from Spain including Santander, Bilbao, Popular and BBK.

The EBA methodology used in carrying out the stress tests is here

A 3-page European overview of the interest rate, unemployment, GDP and inflation assumptions is here

A 4-page European overview of the so-called adverse scenario is here

A 2-page summary of the baseline and adverse scenario by country showing GDP, unemployment, interest rates, exchange rates, inflation, commercial and residential property prices is here.

Approach adopted in stress testing to recognise losses on sovereign bonds is here.

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Full text of judges’ statement on the referendum to reduce their salaries : the statement the Minister had sought to have removed from the courts website

Although it’s not clear when exactly it was drafted, and by whom (the PDF’s author is unhelpfully shown as “User”) and who exactly put their names to it, on Thursday last the Irish Courts Service published onits website – http://www.courts.ie – the complete statement by the Judiciary in response to what is understood to be the proposed wording to be used in the planned referendum to reduce judges’ pay. The 12-page statement by the Judiciary (I used the capital “J” for judiciary to indicate the Irish judiciary and assume there was some degree of consensus as to the content and wording of the statement by all the judges) is available from the courts.ie website here. (UPDATE: 13th July, 2013. The statement has now been removed from the courts.ie website but you can still access it here) You might want to look at it sooner rather than later because it is today reported that the Minister for Justice and Equality and Minister for Defence, Alan Shatter had sought, presumably on Friday last or yesterday, to have the document removed. It seems the minister felt it inappropriate for the document to be published on the courts.ie website. Where he did feel it appropriate to be published is not clear. Boards.ie perhaps, or maybe Twitter machine expert, Vincent Browne might have helped the judges set up a Facebook page? In a display of judicial independence, it seems that the minister has been told to get the lost, for the time being at least, and the Courts Service is, for now, continuing to display the document.

It’s a pretty peculiar story but it seems (it “is understood” according to an article in today’s Sunday Independent) that the reason the Judiciary decided to publish the document in full was in response to what are believed to be selective (or as the judges might say “tendentious”) leaking from the document in the Irish Times last week. Certainly the Irish Times reporter, Paul Cullen was able to correctly claim that the judges’ document was 12-pages long and it seems that the quotes used are indeed taken from the document. The Irish Times further reported that the document was “drawn up by four senior judges at the request of the Chief Justice, Mr Justice John Murray, and the President of the High Court, Mr Justice Nicholas Kearns” and that it was handed by the Judiciary to the new-ish Attorney General, the €169,475-a-year Maire Whelan who is then understood to have passed it on to Minister Shatter. It is not immediately clear from the Irish Times report what passage the judges might have felt was “selective”. There is a second article from the Irish Times last week which reported an interview with Minister Shatter where a number of matters, including the planned referendum, were discussed. Perhaps the judges just wanted to make sure their side of the story was in the public domain to ensure there was an informed debate on the wording to be used in any referendum. That being the case, one would wonder what the appropriate forum was for the publication of the judges’ views. Hardly the Department of Justice and Equality’s website. At 12-pages, it’s too long for a letter to the Irish Times.

The document itself is an interesting argument in favour of an independent body to determine judges’ pay. The judges state that it is not the principle of a pay-cut that is at issue, but instead how a pay-cut is to be effected. Mind you, the judges do set out over at least five of the 12 pages why pay is so important and particularly highlight restrictions on judges which might justify high rates of pay eg inability of judges to practice after retirement, exclusion of certain roles after retirement, inability of judges to secure income from other offices (didn’t stop some of them speculating on the property boom though)

There are extensive references to constitutional judicial independence elsewhere – theUSA,Canadaand the EU for example. And the judges say “many judges dealing with asylum and immigration cases have encountered country of origin information dealing with the position of judges in developing countries where the independence of the judiciary is parlous and where such judges have limited institutional independence”

The document is remarkably illiterate eg “The ultimate decision on would, of course, be entirely a matter for Oireachtas and the People” but its main defect is the omission of any real detail on how to ensure the independence of the body advocated to determine judges’ pay. Or indeed the rules to be adopted by such a body. The judges do make the case well that pay is an important part of the role and that political interference in the setting of ongoing pay must be resisted, lest the independence of judges be put in jeopardy. The judges have particular issue with the indeterminate effects of the proposed wording which they see as exposing the judiciary to, perhaps unintended, ongoing political interference.

And again, the judges’ document is available here. (UPDATE: 13th July, 2013. The statement has now been removed from the courts.ie website but you can still access it here)

UPDATE: 11th July, 2011. The Department of Justice and Equality has provided the Minister’s statement issued yesterday evening, and it is reproduced below.

“Statement by Alan Shatter TD, Minister for Justice, Equality and Defence relating to Referendum on Judicial Salaries.

Our Constitution is based on the doctrine of separation of powers which delineates the separate responsibilities of the 3 major institutions of State, Government, Parliament and the Judiciary.  A central principle of the separation of powers is that each of these institutions respects the independent role of each and exercises its function as prescribed by the Constitution.  Put at its most simplistic, it is the obligation of the Government to govern, the Parliament to legislate and the Judiciary to adjudicate.  The roles of each also on occasion interact, in that the Government is accountable to Parliament and laws enacted by Parliament can be struck down by our courts where they violate constitutional principle.

It is crucial to the functioning of our democracy that each of these institutions show due respect to the roles played by each and avoid entering into areas that go beyond constitutional propriety.  In this context, the independence of our Judiciary is crucial in the hearing and determination of cases that come before the courts and neither government nor parliament has any role in the adjudicative process.  For its part, in a variety of court cases, the courts have recognised that there are crucial areas reserved to government and parliament in respect of which the courts and the judiciary should play no role and that it is for those democratically elected to office, carrying out the duties of government with the support of parliament, to make decisions about fiscal and social policy and to propose and enact legislation. Moreover, our Constitution details the procedure applicable to the holding of a referendum on any issue. It  reserves to the Houses of the Oireachtas the legislative process to initiate the Bill required to ultimately facilitate the people determining in a referendum whether to support or oppose any proposed amendment to the Constitution.

The courts, quite rightly, jealously safeguard their independent adjudicative function from interference by Government or the legislature and the courts’ right to do so is given full respect.  That concept of respect and judicial independence also requires that the judiciary do not engage in political advocacy and show due respect for the role of government and parliament.

It is in the public interest that we maintain public respect for each of the 3 major institutions of State which operate under our constitution and that each is seen to fully play their constitutional role in harmony. Unnecessary controversy has arisen over the commitment in the Programme for Government to hold a constitutional referendum to facilitate application to the judiciary of reductions in salaries which reflect those reductions already imposed across the public service.  This measure poses no threat of any nature whatsoever to judicial independence in that it is merely concerned with ensuring judicial salaries are treated in the same manner as the treatment of similar salaries across the public service.  There is no question of the judiciary being treated differently to others or of being individually or collectively targeted either now or in the future.  The measure is intended to ensure continued public respect for the judiciary and to remove any public perception that the judiciary are immune from the unprecedented economic and fiscal difficulties confronting the State which have impacted on the salaries of all who are paid out of the public purse.

It was brought to my attention on Friday that a memorandum on the issue of judicial pay  critical of  the governments approach to this issue had been placed on the website of the Courts Service, courts.ie.  I was surprised to learn of its posting on this website which is essentially provided at State expense to facilitate the publication of court judgements and  information about the courts and court services.  I can confirm that I asked an official in my Department to inform the Chief Executive of the Courts Service that I did not believe this posting  to be appropriate.  At all times, I was conscious that the Courts Service has an independent statutory role and it was ultimately for the Courts Service to determine what action to take.  I was also conscious of the regular interaction between my Department and the Courts Service in addressing issues in the public interest in relation to courts matters. I am disappointed that this memorandum continues to be posted on the Courts Services website.  I am not aware of any similar publication being posted in the past on the website of a Government Department or a State Agency in circumstances in which an issue arose concerning the salaries of individuals paid through such Government Department or State Agency.  I believe that this event, which was not sanctioned by anyone associated with the government, is most unfortunate and it remains my hope that corrective action will be taken.”

UPDATE: 4th September, 2011. The Department of Justice has published the text of the amendment to the Constitution. The intention is to replace article 35.5 which presently states

“The remuneration of a judge shall not be reduced during his continuance in office.”

with

“35.5.1° The remuneration of judges shall not be reduced during their continuance in office save in accordance with this section.
35.5.2° The remuneration of judges is subject to the imposition of taxes, levies or other charges that are imposed by law on persons generally or persons belonging to a particular class.
35.5.3° Where, before or after the enactment into law of this section, reductions have been or are made by law to the remuneration of persons belonging to classes of persons whose remuneration is paid out of public money and such law states that those reductions are in the public interest, provision may also be made by law to make reductions to the remuneration of judges.”

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