LONDON Supervisors across the European Union will examine the way that top banks classify and value loans and other assets to ensure that the stress tests they conduct do a better job of finding any problems.
The European Banking Authority (EBA) said on Thursday it will set out guidelines for the review, which will delay the bloc's next round of stress tests until 2014.
EBA Chairman Andrea Enria said the checks would help boost the credibility of the next pan-EU stress test of banks.
Previous stress tests failed to spot problems on bank balance sheets in euro zone countries including Spain, Ireland and Cyprus which required international bailouts.
The European Central Bank needs to find any remaining problem areas before taking banks under its wing in the first stage of a planned banking union covering the 17-country euro zone.
The results will also be important for the debate over the next stage of the banking union - the creation of an authority to wind up troubled euro zone banks quickly.
The asset quality review will be conducted by the ECB in the 17 EU countries that are joining the new European Banking Union and whose banks the central bank will directly supervise from 2014.
In the remaining 10 EU member states, the national banking regulator will conduct the review, selecting which banks to focus on and which assets to scrutinize.
The EBA said the actual timing of the asset review and subsequent stress test will be determined once a new law setting up the ECB as banking supervisor is adopted.
The results of the asset quality reviews are expected to be published alongside the outcome of next year's stress test.
In the meantime, the EBA said it would publish an update later this year on banking exposures. This could detail what a bank's capital buffer includes and its holdings of sovereign debt.
In the last stress test, the EU's main banks were ordered to hold capital equivalent to 9 percent of their risk-weighted assets.
At the EBA board decided the asset review exercise planned by the ECB should be widened beyond the euro zone to all the European Union to provide a more consistent foundation for the pan-EU stress test to follow.
In some countries such as Britain, in-depth asset quality reviews have already taken place, and so some banks may be spared further regulatory reviews.
Questions were raised after previous stress tests over the quality of assets, how banks weighted them for risk and the extent to which banks were slow to write off souring loans.
Given that the ECB's review of asset quality is likely to be rigorous, this will put pressure on national supervisors outside the banking union countries to be equally forensic.
A study by the EBA has already shown big discrepancies between banks over the risk weights they attach to assets, calling into question the reliability of capital ratios, their main benchmark of health.
The asset quality reviews will help shape the EBA's ongoing work in monitoring risk weights and any action it takes.
(Reporting by Huw Jones; editing by Jane Baird)