EU regulators unveil details of bank stress tests

European Union banks will be ranked on how well they can withstand a 21.2 per cent slump in home values, coupled with a surge in unemployment and plummeting economic growth, as part of the bleakest scenario in the most severe EU stress test to date.

The exams will also simulate a 19.2 per cent drop in stock prices over three years, as well as a 14.7 per cent fall in commercial real-estate prices across the 28-nation EU, the European Banking Authority said in a statement.

The Hungarian forint and Polish zloty will lose a quarter of their value under the so-called adverse scenario to express losses on mortgage lending in central and eastern Europe.

As the European Central Bank prepares to take over supervision of about 130 euro-area lenders from BNP Paribas to National Bank of Greece starting in November, regulators have sought to compile the toughest stress tests in a bid to repair credibility damaged by assessments in 2010 and 2011 that didn't uncover weaknesses at banks that later failed.

“The exercise’s full transparency will be key to its credibility,” Andrea Enria, chairman of the EBA, said in the statement.

The tests will form a “robust and effective tool for supervisors to address remaining vulnerabilities in the EU.”

The exams will simulate output that misses the European Commission’s growth forecasts in 2014 through 2016 by a cumulative 7 percentage points, with a corresponding rise in unemployment to 13 per cent and stagnant consumer prices.

The scenarios address criticisms of the 2011 test, which modeled the effect of a fall in output of 0.4 per cent that year, followed by a year of static growth in 2012. The adverse scenarios then were overtaken by reality a year later.

Economic activity fell 0.4 per cent in 2012, according to data compiled by Eurostat.

The exercise, which will examine a sample of 124 banks that cover more than half of each EU member state’s banking industry, is scheduled to begin about the end of May, while results will be published at the end of October.

It will form the last part of ECB president Mario Draghi’s effort to stamp out lingering doubts about the health of the region’s lenders before his institution becomes the euro-area’s prime bank supervisor.

The adverse scenario is designed to undershoot EU growth and unemployment forecasts, which make up the so-called baseline scenario, to simulate financial stress and help banks identify where they could be most vulnerable.

Bloomberg