June 7, 2017 / 4:36 PM / a year ago

Next EU bank stress test to be tougher on bad loan accounting

LONDON (Reuters) - Next year’s stress test of top European Union banks will include tougher accounting for soured loans and a stricter exclusion of funds from asset sales which have not yet been completed, the bloc’s banking watchdog said.

FILE PHOTO: European Union (EU) flags fly in front of the European Central Bank (ECB) headquarters in Frankfurt, Germany, December 3, 2015. REUTERS/Ralph Orlowski/File Photo

The theoretical economic and market shocks 49 banks will face will not be published until next year, but the European Banking Authority (EBA) issued a draft “methodology” on its 2018 health check for public consultation on Wednesday.

The “stress test” will probably be the last conducted from the London base of the EBA, which must move to an EU state due to Britain’s departure from the bloc.

As in the 2016 test, there will be no pass or fail mark for each bank when the results are published in mid-2018.

The test, based on end-2017 balance sheets, will look at shocks from bad loans, market turbulence, and the impact of fines for misconduct.

Additionally, in January 2018 banks in Europe will have to comply with a new accounting rule, known as IFRS 9, which forces them to provision for souring loans much sooner than at present.

The new book-keeping rule is expected to force banks to hold more capital, though regulators have decided to give lenders time to find this extra capital in practise.

EBA, which has repeatedly warned that dealing with bad loans must be a top priority for banks, said banks will have to reflect the impact of the new rule at the start of the test and throughout its theoretical three-year duration.

And lenders will not be able to factor in any uplift to capital from a sale due to happen during the test period.

“Any divestments, capital measures or other transactions that were not completed before 31 December 2017, even if they were agreed upon before this date, should not be taken into account in the projections,” EBA said.

The European Central Bank, which supervises 35 of the banks being tested, was forced to justify allowing Deutsche Bank (DBKGn.DE) to include proceeds from a sale of a stake in a Chinese lender in its 2016 stress test result.

The sale did not actually go ahead during the test, even though it boosted Deutsche Bank’s capital buffer in the result.

Editing by Alexander Smith

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