Wall Street Journal: Europe's bank stress tests minimized debt risks

By some estimates European banks are holding over €2 trillion of private and sovereign debt from Greece, Spain and Portugal, all of which face sharp downgrades on sovereign debt. The ECB accepts these bonds at above-market valuations as collateral for the liquidity it provides the banks (who cannot get it from interbank/wholesale funding markets) and is thus hiding the problem of under-capitalisation. The recent stress tests, showing that banks were relatively unexposed to this sovereign debt, were part of this sleight-of-hand. This article shows the massive gap between the sovereign bonds the banks actually hold (a lot) and what they say they hold (not a lot). The BIS says French banks hold nearly €35 billion of Spanish sovereign debt but the stress tests say it's only €6.6 bn.