REUTERS SUMMIT-More to EU bank health check than "blood on the floor"

Wed Apr 30, 2014 9:51am EDT

(For other news from Reuters Financial Regulation Summit, click here))

* EU banks test should not be judged by 'blood on the floor'

* Banks may have to boost capital by curbing bonuses, divs

* Central banks can decide timing for raising capital

* Having ECB in town is an "important factor"

LONDON, April 30 (Reuters) - A health check of Europe's banks taking place this year could mean bigger constraints on banks' behaviour in the future, including on their ability to pay dividends and bonuses, a senior European Union regulator said on Wednesday.

Piers Haben, director of oversight at the European Banking Authority, also said the results of the tests, to be published in October, will not only show whether banks must raise capital but could also be used as a tool to determine how banks spend their future earnings.

He said the significance of the tests would not simply be an exercise in spotting the weaker players.

"In 2014 there will be some focus on blood on the floor," Haben told the Reuters Regulation Summit. "But it's very important for supervisors to reflect on the range of options at their disposal to make sure banks are resilient to potential adverse conditions."

Haben said it was too early to say what actions supervisors could take, beyond demanding capital increases, but they could include forcing banks to rein in dividends and bonuses.

This would mirror the approach taken by the U.S. Federal Reserve, which has used the results of its stress tests on banks to force some to scale back dividends.

The Fed's tests have been viewed by the markets as more credible than EU tests in 2010 and 2011, which failed to convince markets that all the problem assets on banks' balance sheets had been rooted out.

"The issue for us is are these exercises credible in shining a light on potential vulnerabilities in EU banks and the EU banking sector," said Haben, who cycled to Reuters' Canary Wharf office to beat a transport strike in London.

"I don't believe the proof is blood on the floor. I believe the proof is in explaining exactly what we are doing and full disclosure of our results."

In previous tests the EU watchdog came up against vested interests, not least among national regulators, but this time round the European Central Bank is throwing its weight behind the exercise. The ECB is taking responsibility for the 18 euro zone countries' assessment of balance sheets before it becomes their supervisor from November.

Haben said it would be the ECB that decides what action euro zone banks must take after the results are published, rather than national supervisors in the euro zone states.

"The fact the ECB is in control for euro zone countries is a very important factor," he said.

CREDIBILITY

Details of the scenarios being used to test the balance sheet strength of 124 of the EU's major top banks were published on Tuesday. The health check aims to draw a line under the 2007-09 financial crisis that led to a string of bank bailouts in the EU paid for by taxpayers.

Banks must show they would still hold core capital equivalent to 5.5 percent of their risk-weighted assets after suffering simultaneous slumps in economic growth, property prices and stock markets.

Passing the test may not be enough. Haben said that supervisors would not only be interested in banks that fell below the threshold. Banks that stay above the 5.5 percent watermark but are still significantly impacted by the shocks could also be subject to supervisory actions, he said.

"As supervisors, what we are interested in are vulnerabilities, and whether a bank falls below 5.5 percent or stays above 5.5 percent but (also) has a significant impact from the shocks, will determine the supervisory function reaction."

The ECB said on Tuesday that euro zone banks would be given six months to raise capital if they had a capital shortfall under the most likely economic scenarios over three years. Banks needing capital under an adverse scenario - three years of recession - would have nine months to raise it.

Haben said the other 10 EU supervisory authorities would be able to set their own time scales for their banks' capital raising, in a marked departure from the 2011 European stress tests where the EBA set harmonised time frames across the EU.

"These issues are discussed at our table (of EU supervisors)," he said. "It's possible we will provide a recommendation at the end if that's needed".

The reaction so far to details of the EBA stress test has been fairly positive, Haben said. Analysts at Credit Suisse bank said on Wednesday that tougher elements in this year's test have increased its credibility.

The watchdog has to review each year whether to conduct a stress test of banks but no decision has been taken for 2015, though banks are expected to conduct their own tests annually.

"The question for us is: Is that something we want to do at an EU level as well?" Haben said. "We will need to take stock of that after this exercise."

Follow Reuters Summits on Twitter @Reuters_Summits (Reporting by Huw Jones, Laura Noonan and Steve Slater. Editing by Jane Merriman)

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