david.fm

Strategy: Banks and Regulations in Europe

- French Economy Minister Lagarde voiced her optimism about the upcoming stress tests results to be releases by
July 23. As Der Spiegel reported last week apparently some regulators were against the sovereign default scenarios to be part of the tests so the devil is in the detail and much depends on which methodology will be used. I feel that a sovereign default scenario is very difficult to forecast and unlikely to happen, at least in the short-medium term.

In my opinion most of the European banks will pass the stress tests and surprise positively BUT to be successful these tests need to be transparent, have a credible and solid methodology and a clear conclusion/action plan.

- Markets perceived the call for austerity of ECB President Trichet as bad news. The are clearly two predominant school of thinking - the American "call to spend" to fuel growth and the German-European view to reduce deficit with
a set of austerity measure and cost cutting. Given that unemployment in Germany
fell in June to 7.5% and a weaker Euro will boost German exports. The German view seems to be a better solution.

- An excessive strength of the Swiss Francs might have negative impact of Eastern European banks that conducted many of their lending operations in Francs. This might have a negative impact on several banking groups with extensive operations in Eastern Europe.

Summary: European banks will likely pass the stress test without major problem but the market might not perceive that positively unless there is a convincing methodology.
European strategy to reduce deficit is certainly positive, it might not seems so in the immediate short term, but on the medium long term it will certainly pay off. Despite the gloom Germany and other European economies remain highly competitive, especially with a lower Euro. I feel that despite the volatility European banks, particularly these traded in Euro, are reasonably priced and in many cases (smaller regional banks with clean balance sheets) present limit risks. Many of the scenario proposed with Sovereign default are, given the European 720bn package, unrealistic. Swiss investments (and Swiss Francs denominated asset) highly recommended. A centralized European banking regulator might not add much value.