Bank stress test to use tougher measures than previously

The European Banking Authority yesterday unveiled plans for how it will test the health of Europe's biggest banks, outlining a set of strict criteria by which lenders will be stress-tested in the coming months.

With the London-based authority under pressure to prove its mettle following two previous rounds of tests in 2010 and 2011 that failed to spot weaknesses in the banking system, the EBA said yesterday banks would be tested to withstand a 21.2 per cent fall in house values, a 7 per cent fall in gross domestic product and a 19 per cent drop in share prices under a “worst-case” scenario.

The tests, which will begin by the end of next month, will cover 124 banks across the European Union – about half of the European banking sector.

The “adverse scenario” model, devised by the European Systemic Risk Board, outlines a number of risks considered to be “the most pertinent threats to the stability of the EU banking sector”. These include: an increase in global bond yields, particularly in emerging markets, a further deterioration of credit quality in countries with weak demand, a failure to implement economic reforms and difficulties in accessing market funding.

Robust tool
The EBA's chairman Andrea Enria said the exercise's full transparency would be key to its credibility. "The methodology developed by the EBA for the stress test will ensure a robust and effective tool for supervisors to address remaining vulnerabilities in the EU banking sector," he said.

Separately, the European Central Bank announced that banks partaking in its asset quality reviews, which will feed into the EBA's tests, will have six to nine months to raise capital following the announcement of the reviews' results. With the results expected to be published in October, this gives banks to the middle of next year to raise funds should capital be needed, with the ECB noting that the capital shortfalls must be covered by common equity tier-one capital. The use of additional tier-one capital to cover shortfalls arising from adverse stress-test scenarios would be "limited" the bank said, depending on the trigger point of conversion or write-down.

Vitor Constâncio, vice-president of the ECB, said that banks should start to consider what private sources of capital could be raised in anticipation of any possible shortfalls and plan accordingly. He noted that the capital plans which banks will be obliged to present can include “retained earnings, reduced bonus payments, new issuances of common equity, suitable strong contingent capital and sales of selected assets at market prices”.

Danièle Nouy, chair of the ECB’s new supervisory arm, the Single Supervisory Mechanism said “intensive activity” on the asset-quality reviews of euro zone banks was continuing, involving approximately 6,000 supervisors and auditors across the euro area. These reviews will take place in parallel to the forward-looking stress tests being undertaken by the European Banking Authority, and their findings incorporated into the stress-test results, as part of the “comprehensive assessment” of the European banking sector.

In a major expansion of its powers, the ECB will assume supervisory control of the euro zone’s biggest banks in November, as part of the move towards a euro-wide “banking union”, but has insisted on examining the state of the banks’ balance sheets before taking over.

Ratings revised
Separately, 15 European banks, including Bank of Ireland, have had the outlook on their credit ratings cut to "negative" from "stable" by Standard & Poor's.

The agency said the move reflects efforts by European governments to require creditors rather than taxpayers to bear the burden of the costs. Others to be downgraded included Barclays in the UK and Deutsche Bank in Germany.