* Test includes surge in unemployment and economic
* Includes average fall of a fifth in property prices
* Results of test due in October
By Huw Jones
LONDON, April 29 European banks must show they
can survive simultaneous routs in bonds, property and stocks in
the toughest test to date by regulators aiming to restore
confidence in an industry that had to be rescued by taxpayers in
the financial crisis.
The European Banking Authority (EBA) said on Tuesday it
would gauge the resilience of 124 banks from the 28-country
European Union to see if they would still have enough capital
after facing a toxic cocktail of theoretical shocks.
The EU watchdog set out "scenarios" banks such as Deutsche
Bank, BNP Paribas and Barclays face in a test whose results will
be published in October, raising hopes among policymakers that
banks can finally turn a corner and lend more to the economy.
Over a three-year "stress test" period - a year longer than
in the previous exercise - banks must show they can cope with a
cumulative loss of 2.1 percent in economic output, much worse
than the 0.4 percent decline in the last test.
Such a poor economic performance would push up unemployment
to 13 percent and send house prices down 20 percent on average,
triggering defaults on loans held by banks on trading books, the
Separately, European insurers are also being tested by their
regulator, as policymakers seek to address market criticism that
the EU has not been as robust in its response to the financial
crisis as the United States.
European banks such as UniCredit are already bolstering
their capital to avoid the humiliation of failing the test, and
before the European Central Bank (ECB) becomes their supervisor
from November as part of a new euro zone banking union to
intensify scrutiny of lenders.
Previous tests failed to convince markets and this time
round the ECB is reviewing the balance sheets of the top euro
zone banks to ensure the stress test is based on reliable
numbers in the first place.
"The exercise's full transparency will be key to its
credibility," EBA Chairman Andrea Enria said in a statement
outlining the mix of shocks banks would face in the stress test.
"It will show how efforts recently undertaken by EU banks
are already bearing fruit and it will provide a common framework
for the next steps to be taken by supervisors and banks."
Banks that fail the test will be given time to plug capital
holes by raising money from investors, scrapping dividends or
Although the European economy is improving after several
years of fallout from a banking and euro zone debt crisis since
2007, regulators opted for their toughest test yet after the
failure of each of the previous three exercises to convince
markets that banks have enough capital.
The EBA had already said the test would cover three years
from January 2014, during which banks would have to maintain
core capital equivalent to at least 5.5 percent of their
risk-weighted assets to pass, a higher threshold than in the
The impact of the theoretical economic slowdown will be felt
in six shocks hitting all assets held on banks' trading books,
compared with two shocks in the prior test.
This time round banks cannot include planned measures to
boost capital after the December 2013 cut off date for the test.
Banks will also have to show that while their assets are
being pummelled, they can manage liabilities, meaning they can
foot the higher funding costs such distressed markets would
bring despite the test's cap on income from interest and
Experiences from the recent past are also being included in
the test, such as spikes in market interest rates, and turmoil
in central and eastern European currencies in the wake of recent
foreign exchange crises, such as in Hungary.
The stress test includes national variations in how the
different assets react to the economic downturns.
For example, the gap between expected house prices and the
"adverse" scenarios banks are tested against varies massively,
with banks in Britain, Sweden and Finland tested against the
biggest departures from expectations and banks in Spain and
Portugal, which have already suffered massively property slumps,
tested against the smallest slumps.
Tests against a commercial property collapse are most severe
in the Britain, Sweden and Denmark and least severe in Austria,
Portugal and Spain.
The test will also set tougher criteria on government debt
holdings. The bulk of sovereign debt held by lenders is in the
so-called available for sale (AFS) category in trading books,
and some national regulators allow banks to ignore the impact of
market slides on this category in real life.
Despite opposition from some regulators, the EBA test will
impose a common phase-out of this protection where it exists, so
that by the third year, at least 60 percent of AFS would be
The watchdog hopes the test results and data will be
detailed enough so that analysts can replicate it with their own
computer models as a cross check.
(Additional reporting by Laura Noonan; Editing by Mark Potter)