ECB to reveal bank stress test strategy by end of March

The European Central Bank kept the euro zone's top lenders on tenterhooks as it promised to reveal the strategy for its unprecedented review of bank balance sheets by the end of March, giving only scant detail today.

The ECB’s asset quality review, or AQR, is part of a broader examination that also includes a stress test to see how banks hold up under shock scenarios, to avoid nasty surprises once it starts supervising them from November.

The exercise aims to encourage banks to recognise losses on loans or investments that have soured over time, allowing them to regain investors’ trust and free up capacity to grant new loans to help along the euro zone’s fragile economic recovery.

"We believe very much that recovery in 2015 will benefit from this exercise," ECB vice president Vitor Constancio told reporters at a news conference.

Confidence in the sector remains fragile despite more than €1 trillion of state support since the global financial crisis and the euro zone debt crisis underlined the risky relationship between overindebted governments and the banks who buy many of their sovereign bonds.

The EU’s latest health checks are intended to settle any lingering doubts over its finances.

On Friday, the European Banking Authority (EBA) set out parameters for the stress tests and the ECB said it would apply them as well, aiming to give banks the stress test scenarios by the end of April.

Euro zone banks will get some time to meet the capital shortfalls highlighted by the scenarios, but the gaps from the baseline scenario in which banks must have a core capital ratio above 8 per cent need to be addressed right away.

“A shortfall relative to the baseline scenario will require that capital be raised in the nearer term, whereas a shortfall arising from the adverse scenario may only require capital to be raised over a more extended period, on the basis of an agreed capital plan,” the ECB said in a statement.

On the key question of how government bonds will be treated, the ECB said that sovereign debt held in the available-for-sale and held-for-trading portfolios would be marked-to-market.

The AQR and the stress tests will feed into each other and their timings will overlap somewhat, but the overall result -spelling out the size of any capital shortfall - will only be published in October.

Analysts have estimated the tests will show the banks need up to €100 billion of fresh capital.

Over the past couple of months, the ECB has collected vast streams of data from the 128 banks that are taking part in the exercise and some lenders have to deliver extensive detail on their trading books and risk models by February 7th.

National supervisors have also identified particularly risky portfolios they would like included in the in-depth review, which the ECB will review and approve by mid-February.

The actual review of assets, collateral and provisioning in the selected portfolios will start in March.

Reuters