* Stress test to cover three years from December 2013
* Core capital must be above 5.5 percent for bank to pass
* Details of actual stress scenarios due in April or May
By Huw Jones
LONDON, Jan 31 European Union banks face their
toughest probe yet in a bid to weed out the sector's weaklings,
the bloc's chief watchdog said on Friday, announcing stress
tests intended to help draw a line under the financial crisis.
More than half a decade since the start of the 2008-2009
credit crunch, and despite more than 1 trillion euros ($1.4
trillion) of state support, confidence in the sector remains
fragile and the EU's latest health checks are intended to settle
any lingering doubts over its finances.
The European Banking Authority (EBA), the EU watchdog
coordinating the tests, said on Friday that to pass, banks must
have a core capital ratio of above 5.5 percent during the
three-year stressed scenario, including above 8 percent at the
This reflects the amount of capital reserves banks have to
put aside to cover unpaid loans or market bets that go wrong. It
represents a significantly higher bar than in previous tests or
before the crisis, when it was typically about 2 percent.
The theoretical stresses lenders will face, such as a market
meltdown, won't be published until April or May. The threshold
for the 2011 test was 5 percent and some lenders that were above
this level had to be rescued later in EU bailouts.
The 2014 tests will apply to 124 banks from across the EU,
accounting for roughly 30 trillion euros in assets or about 80
percent of the bloc's banking sector.
This is up from 91 in the previous exercise and includes 104
from the euro zone, including leading lenders such as Deutsche
Bank, Santander, BNP Paribas and
Monte dei Paschi.
The EBA also mapped out a timeline and common methodology
that must be applied to all banks, but some national supervisors
will add additional risks to be tested.
Germany, for example, is likely to also test for exposure to
the shipping business, while Britain may want to add an extra
focus on the property sector.
The test will cover three years to December 2016. To be
eligible for inclusion, capital must comply with requirements
under the global Basel III accord for each December in the test.
Basel is being phased in over six years with the rules gradually
tightening over that time.
The outcomes of prior balance sheet reviews, due to be
completed in June, and the stress test itself, which starts in
May, will be combined into a single result for each lender in
October, spelling out the size of any capital shortfall.
Any extra shortfall due to a national add-on or bespoke test
would be published separately by the national supervisor to
avoid harming comparability of the common EU test results.
Analysts have estimated the tests could show a total
shortfall of up to 100 billion euros.
The EBA has yet to decide how much time a bank would have to
plug a shortfall after the results are published, though
policymakers insist taxpayers are the last stop.
There is also still debate over how to treat bank holdings
of government debt in the so-called "available for sale"
category. Some supervisors may apply a more lenient treatment
than others, but the results in October will make clear what
treatment was applied so analysts can run their own tests.
After the failure of past tests to root out problems, the
stakes are higher this time as the European Central Bank (ECB)
is putting its credibility on the line.
Under a new banking union for the single currency area, the
ECB will directly supervise 130 euro zone lenders from November.
To avoid embarrassments down the line, the ECB is handling
the balance sheet review for euro zone lenders and their stress
tests itself, using new powers to by-pass protective national
supervisors and challenge suspect data from a bank directly.
"This is the game changer," an EU regulatory official said.
The EBA does not have the power to directly challenge
lenders over data, a key flaw in previous tests.
Central bankers say a balance sheet review ahead of the
stress tests, to be carried out for the first time, along with
the use of outside consultants, will make the exercise more
Regulators say increased credibility this time round is
clear from the way banks have already been scrambling to bolster
their capital ratios, mainly by dumping loans, known as
deleveraging, to avoid the humiliation of failing the test.
This deleveraging could pick up again after the test results
are announced in October and supervisors will press lenders to
raise new capital rather than ditch loans, people familiar with
ECB thinking said.
Banks will be under pressure to fill capital holes even
before the test results are announced, and tell markets in June
if the initial review uncovers any major shortfall.