The CEOs of Societe Generale and BNP Paribas told the French media Wednesday that their banks are sound and don't need more capital. The assurances came in response to European Commissioner Joaquin Almunia's comments this week that the euro zone's continuing crisis might lead to another round of bank recapitalizations. They also arrived only hours before a report from the International Monetary Fund estimated that Europe's banks could face €300 billion in losses from the euro-zone conflagration.

Societe Generale's CEO, Frederic Oudea, told Le Figaro that French banks were solid because Europe's stress tests earlier in the year found them to be so. "The stress tests that were conducted showed that a limited number of small institutions had an immediate need for extra capital. That is not the case for the majority of European banks, nor for French banks in particular," he told the newspaper.

But a leaked memo from the EU's Economic and Financial Committee, addressing EU finance ministers and first reported by Dow Jones Newswires, made clear how little comfort they offered to investors in Europe's banks. Though July's tests did find most European (and all French) banks to be sufficiently capitalized, the summer's volatile market action showed "the tests did not manage to restore market confidence." The memo suggests using timelier macroeconomic indicators, after July's tests included "a relatively mild sovereign shock in banking books, a scenario which was clearly taken over by events as months passed by."

To say the least. At this point, most analysts consider an average 40% haircut on Greek sovereign debt to be extremely conservative, along with a corresponding 70% haircut on Greek bank debt. But the latest EU tests didn't apply anything higher than 30% across all maturities.

Europe's stress tests were also generous in what they counted as capital. They evaluated the banks on their "core tier 1 capital," which includes certain instruments that might prove difficult or impossible to liquify in a panic. Under normal liquidity conditions, that's fine. But these aren't normal conditions, meaning that anything other than equity capital becomes questionable when considering creditor losses in the event of liquidation.

Frederic Oudea, CEO of the Societe Generale. Associated Press

Even on this measure, Europe's banks remain relatively undercapitalized, especially heading into a crisis. The IMF puts U.S. banks' core Tier 1 capital at close to 16% as of the end of March, versus just over 10% for German commercial banks, a little under 9% for French banks and barely 7% for Germany's state-owned savings banks.

During the height of the 2008 panic, regulators focused on a narrower definition of capital, known as tangible common equity, which includes banks' reported equity and retained earnings minus goodwill, intangibles and any preferred stock. By its own account, Credit Agricole's tangible common equity is just 2.1% of its assets—which means its €1.6 trillion balance sheet is leveraged nearly 49-to-1. Credit Agricole argues that €500 billion of that should be netted out because of its hybrid banking/insurance business model, which still leaves it leveraged 33 times.



The latest available figures from BNP, Credit Agricole and Societe Generale put their respective banking-book exposures to Portuguese, Italian, Irish, Greek and Spanish public debt at €28.9 billion, €10.3 billion and €4.3 billion respectively. (Some €21 billion of BNP's exposure is to the Italian government.)


In short, the French and euro-zone banking crisis is not, as the European regulators put it in their leaked memo, an "issue of the strength of the message of the EU stress test." It's an issue of the strength of EU banks, which Europe's tests did little to challenge. Until they do, markets and analysts will continue to do their best to estimate losses should the worst, or even the merely inevitable, come to pass.