* 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
* French banking source says ECB already strutting its stuff
* Critics say treatment of sovereign debt still too feeble
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 and
represents a higher bar than in previous tests or before the
crisis, when it was typically about 2 percent.
For the banking sector as a whole a key issue is whether the
tests will force another round of multi-billion euro
capital-raisings via share issues, but the answer to that
question won't emerge until later in the process.
Some banks like Deutsche Bank and Monte dei
Paschi have moved early to bolster their balance
sheets but there may be more to come. The Bank of Italy for
instance has said some smaller Italian lenders may need 1.2
billion euros in total.
Analysts have estimated the tests could show a total
shortfall of up to 100 billion euros.
The 2014 tests will apply to 124 banks across the EU, such
as leading lenders BNP Paribas, accounting for roughly
30 trillion euros in assets. The stresses being tested will be
revealed in April or May.
"The more rigorous the better," said Francisco Gonzalez,
chairman of Spanish bank BBVA. Angel Ron, chairman of
rival Banco Popular, said the 5.5 percent threshold is
demanding but his bank was is "very well prepared".
The EBA is mapping 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, to
which some of its banks lent heavily.
The Bank of England said its own stress test of eight banks,
including Barclays, HSBC and RBS, will
run alongside the common EU test, dashing any hopes among
lenders it would be a substitute.
The outcomes of prior balance sheet or asset quality reviews
(AQR), 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
The German banking lobby said extra national tests would
muddy the picture, but the EBA said they would be reported
separately from the common EU test to make comparisons valid.
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 resort.
There is also 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.
Professor Hans-Peter Burghof of Hohenheim University in
Germany said the treatment of sovereign debt was too feeble,
echoing criticism of past exercises. "The stress test is a very
blunt tool and because of that it is unrealistic to hope that
confidence in European banks will come back," he said.
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.
A French banking source said the ECB was already "strutting
its stuff" by asking for millions of pieces of data to check
exposures line by line.
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, makes the test more rigorous.
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 and supervisors will press lenders to raise new
capital rather than just ditch loans, people familiar with ECB
Banks will be under pressure to fill capital holes even
before the test results are announced, and to tell markets in
June if the initial review uncovers any major shortfall.
Regulators say stopping leaks will be challenging as lenders
may be tempted to reassure investors who face having to wait
months before the formal result.
"It's a shame that the AQR and the stress tests will take so
long, as it's not good to have any uncertainties hanging over
the sector," said Emilio Botin, chairman of Spain's Santander
. "Although I don't have any doubts about Spain."