And financial regulators wonder why smart people don’t trust them…

It was only back in July that the international financial regulators gave the major Irish banks the tick of approval. They were subjected to a rigorous stress test and found to have adequate capital to carry on trading. As the central bank of Ireland reported in a press statement at the time: “The results of the exercise demonstrate that AIB and Bank of Ireland meet the stress requirements and do not require additional capital…”

Commenting on the results of the European exercise, Head of Financial Regulation at the Central Bank, Matthew Elderfield said “The stress test results published today for Ireland’s two largest banks as part of a Europe-wide exercise follow the Central Bank and Financial Regulator’s own stress testing process earlier this year under our Prudential Capital Assessment Review (PCAR) framework. The PCAR stresses were set at a severe stress level and it is therefore consistent with our earlier exercise that the Irish banks have achieved the target level of capital in the EU process. In our application of the EU stress test we have, as a prudent measure, decided to apply a number of the more demanding PCAR parameters – the Irish banks also meet the target level of capital against this standard, but with less headroom.”

He added, “These results take account of the additional capital previously prescribed by the Central Bank under the PCAR. Bank of Ireland has already met these targets and we continue to work with AIB as it executes its capital raising plan to meet our year end-deadline. We are also continuing our PCAR work with the other Irish banks and will keep the capital position of the Irish banking sector under review, conducting further stress testing exercises in the future to benchmark prudential capital requirements in light of market developments.”

The objective of the EU-wide stress test exercise was mandated by the EU Council of Ministers of Finance (ECOFIN) and coordinated by CEBS in cooperation with the European Central Bank, national regulators and the EU Commission, to assess the overall resilience of the EU banking sector and the banks’ ability to absorb further possible shocks on credit and market risks, including sovereign risks.

The exercise was carried out on a bank-by-bank basis for a sample of 91 EU banks from 20 EU Member States, covering at least 50% of the banking sector, in terms of total consolidated assets, in each of the 27 EU Member States. The exercise used commonly agreed macro-economic scenarios (benchmark and adverse) for 2010 and 2011, in cooperation with the ECB and the European Commission.

The stress test required banks to meet a 6% Tier 1 target capital ratio. It was conducted using country and market specific methodologies, shocks and assumptions provided by CEBS including loan loss rates, resulting from Probability of Default (PD) and Loss Given Default (LGD) estimates, on loan books and market shocks to trading books. The test additionally applied stress parameters to both banking and trading books for a sustained sovereign stress.

In completing the CEBS stress test, the Central Bank and Financial Regulator applied higher loan loss rates to both the NAMA loans and the non-NAMA investment and development property loans than was required by CEBS. In each of these loan categories the PCAR loss rates were applied. This resulted in a more demanding stress test than was prescribed by CEBS due to the specific PCAR loss rates applied to these exposures.

Both the CEBS and PCAR exercises have subjected AIB and Bank of Ireland to rigorous stress testing, scrutiny and challenge. While both have different assumptions and methodologies, they apply a robust, realistic and prudent capital standard informed by detailed analysis and by emerging best practice internationally.

It certainly read very impressively. Not a worry in the world. The Irish banks are in the very best of hands.

Fast forward four months.

As the other major Irish paper the Irish Times put it:

A DRAMATIC fall in the value of Irish bank stocks led a global sell-off in equities yesterday, as markets failed to be convinced that Ireland’s EU-IMF plan will solve the euro zone’s financial woes.

The value of the euro and peripheral euro zone government bonds also fell sharply as fears about the health of the euro zone mounted.

Bank of Ireland tumbled by 23 per cent, closing at 30 cent, as investors rushed to sell their holdings of the bank’s shares.

AIB shed 19 per cent to finish at €0.33, while Irish Life Permanent shed 10 per cent to €0.75.

The sell-off was due to fears that Irish banks would be nationalised or, at the very least, shareholder value would be severely diluted in the event that the Government increases its stake in the State’s main lenders, a move that is widely expected.