Only 17 out of the 91 European Union's banks failed their stress test. The ultimate goal of the stress test was to give the global markets more confidence in the EU. The results were released last week and so were the criteria. No one expected the criteria to be so tough.
These tests ran a bank's balance sheets through a series of worse case scenarios. A bank fails the stress test if its Tier-1 capital ratio is below 6% under two scenarios: Adverse scenario and adverse scenario plus sovereign risk. The adverse scenario assumes that the bank must face an economic climate that is so severe that it is only experienced once in 20 years. The same tests in the U.S. last year assumed a once in seven year possibility. These tests assumed a further decrease of 6% in unemployment from current levels and a 6% hike in interest rates from current levels.
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