Fitch as a fiddle final

Bloomberg and AAP/Business Spectator both report breathlessly this morning that the big four banks have passed the Fitch stress test.

The AAP/BS version is particularly flattering:

Under a severe scenario, gross losses could total over $6 billion across all four banks, with net losses reaching 10 per cent of their combined operating profits, Fitch said in a report.

A moderate scenario would see aggregate gross losses climb to just over $2 billion.

But losses within banks’ mortgage portfolios could be readily absorbed under the moderate and severe scenarios, although these would more likely affect banks’ corporate and small to medium enterprise (SME) loan books.

“Should the housing market suffer a shock of this magnitude suggested by the severe and moderate scenarios, it would most likely reflect broader economic deterioration, with implications for credit quality within the banks’ SME and corporate loan portfolios,” Fitch said.

Problem is, the Fitch test didn’t actually account for losses in this broader portfolio. This blogger interviewed the authors of the stress test last year and they outlined that:

…the stress test is a simple credit risk assessment for the big banks’ mortgage portfolios. That is, Fitch asked what would the losses be for the banks in the event of three housing bust scenarios, one mild, one medium and one severe.

The test is a straight three year model without econometrics.

It makes no reference to any macroeconomic scenario.

Nor does it take account of losses in other areas of the banks’ greater portfolio of consumer and business loans.

Nor does it take account of the liability side of the banks’ balance sheets and the liquidity risk buried in their wholesale borrowings.

At the time, this blogger concluded:

In short, the test is the functional equivalent of judging the safety of an aircraft by jumping up and down on its wings. If they hold, we’re cleared for takeoff. The coughing engine, missing tail and dead pilot get ignored.

One wonders why neither news source bothered with alternative comment. For your viewing pleasure, the Fitch reports:

Australian RMBS Housing Stress Test
Australian Major Banks – Mortgage Stress Manageable