EU banks to undergo tougher stress tests

THE EUROPEAN Union’s largest banks will face much tougher stress tests than last year, including the impact on their accounts of higher unemployment, falling house prices and lower economic growth, in a review to be published by the European Banking Authority in June.

The exercise on approximately 88 banks – though the list has not yet been named – will be conducted from March until May, before the final set of figures are signed off by the EBA’s board of supervisors in June.

“Banks’ calculations will be rigorously reviewed and challenged by the respective national supervisors before being analysed, discussed and aggregated by the EBA, which will conduct in-depth consistency checks,” said the EBA.

The EBA’s 2010 stress tests were heavily criticised after it had argued that banks needed just €3.5 billion of capital, just a fraction of the amount believed necessary by market analysts.

The stress tests will be carried out “on a broadly similar group of banks” as last year, covering 65 per cent of total EU banking assets and at least 50 per cent of the banking sector in each state, the EBA said at a briefing in London.

Banks will be required to evaluate at fair value all of the exposures on their trading books, with all gains and losses deducted from the net trading income over the two-year duration of the exercise.

The tests will assume a possible deterioration of four percentage points from the baseline set down by the European Commission in its autumn 2010 forecast, compared with a three percentage point possible decline in the first tests.

“The first key component of the scenario is an assumed aggravation of the ongoing EU sovereign debt crisis as of early 2011, adversely affecting a number of asset prices,” said the European Central Bank, in an accompanying note.

Equally, regulators are also assuming that “in line with the persisting EU sovereign debt crisis, there will be renewed tensions in European money markets, altogether contributing to an increase in short-term interest inter-bank rates by 125 basis points”, the ECB note added.

Liquidity risk is not to be “specifically assessed” in the exercise, since the EBA is doing so in other inquiries, though the tests will assess the impact of higher interest rates on banks’ assets and borrowings.

The tests will assume that no workout of defaulted assets has occurred: “The EBA understand that many banks feel this assumption is overly onerous and makes the stress test very severe. However, to ensure the robustness of this exercise and consistency across the entire sample of banks it is vital this assumption is respected.”

The tests by the EBA will be useful and more consistent than last year’s exercise but the United Kingdom’s examination of its own banks will be tougher, Financial Services Authority chairman Adair Turner said.

“I suspect you will find that our parameters will be tougher and tighter than the European ones. They were last year,” he said.

However, the Association of German Banks warned that the stress tests could undermine confidence because the results can be misread, because some banks could fail the test yet “fulfil regulatory requirements, have stable business models and not be close to insolvency”.

Calling for the results of individual banks not to be published, Dirk Jaeger, managing director of the association, said the test should not include minimum capital hurdles and tougher definitions for reserves.