April 8, 2011 / 11:53 AM / 9 years ago

Q&A: What EU banks must do to pass the stress test

LONDON (Reuters) - The European Banking Authority says 90 lenders will sit this year’s bank test, aimed at reassuring taxpayers and repairing the sector’s image.

The EBA announced last month the details of the recession imagined by the test. Banks must have core capital above 5 percent to pass.

On Friday it published the pass mark, list of banks being tested and what type of capital will be eligible for passing.

WHAT IS THE PASS MARK? The 90 banks being tested will have to show they have a core Tier 1 ratio — the most stringent benchmark of a bank’s stability — of 5 percent under the stress test’s scenario of a two-year recession and slump in property prices.

The EBA says any bank that only scrapes a pass will also have to show how it will address “specific weaknesses.”

The sample of banks represents more than 65 percent of EU banking assets.

WHAT DO BANKS NEED TO PASS? Capital eligible for inclusion in a bank’s core Tier 1 capital ratio must largely be ordinary shares with all hybrid instruments stripped out, including preference shares.

The EBA says the definition is stricter than in many countries at the moment and is in line with the tougher Basel III rules that are being phased in from 2013. The stress test will allow more flexibility as Basel III does not take full effect until 2019.

The standard of capital for passing can also include government support schemes since the financial crisis unfolded.

Any holdings that expire before the end of 2012, the period covered by the stress test, would not be eligible.

All components of core Tier 1 capital put forward by the banks will be published — a step which will be required anyway from 2013 under Basel III.

WILL ALL OF GERMANY’S SILENT PARTICIPATIONS BE ELIGIBLE?

No.

The EBA says that silent participations, a form of hybrid debt, are not eligible if they date back to before the financial crisis.

Only those issued since the crisis and thus funded by the German government are eligible, and accepted locally for inclusion in core Tier 1. This applies to banks such as Commerzbank.

WHAT ABOUT BANKS WHO ARE RAISING CAPITAL EARLY?

Some Italian banks like Intesa Sanpaolo and Germany’s Commerzbank are already pushing ahead with plans to raise fresh capital, helping to make sure they pass the test.

The EBA says if capital raising plans are announced and are being implemented by the end of April, they can be counted toward the 5 percent pass mark. Capital raised after this date cannot be counted, but banks can detail them for supervisors to consider in their overall assessment.

HOW MUCH TIME DO THE BANKS HAVE? The results of the test are due at the end of June and all banks that have failed will have to outline what they are going to do improve their capital levels.

Raising fresh capital is just one option and several banks have already begun doing that.

Banks can also signal they are planning to deleverage by selling off a part of their business so they don’t have to hold as much regulatory capital. They could also agree to be taken over or, in extreme cases, be wound up.

Lenders will have until the end of the year to plan with national regulators how to avoid having to call on investors for extra cash at the same time or trigger fire sales of assets which would push down their value.

Reporting by Huw Jones and Steve Slater, editing by Sophie Walker

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