Tags: Europe | Sets | Higher | Bar | Bank | Stress | Tests

Europe Sets Higher Bar for Bank Stress Tests

Friday, 08 Apr 2011 01:23 PM

European regulators say a new round of stress tests on banks will use tougher standards to make sure they are credible and boost confidence that the banking sector can get through the debt crisis that has forced three countries to ask for bailouts.

The European Banking Authority said Friday that, for the purpose of the tests, it will use stricter standards for the financial assets banks must keep back as capital in case of unexpected losses.

It will now count what bankers call the Core Tier 1 capital, which excludes some kinds of assets allowed under the plain Tier 1 standard used in last year's tests. Those tests were regarded as not tough enough to be credible.

If banks fail the tests, they could be asked by national regulators to raise more capital from investors or shrink their exposure to risk.

The tighter definition is aimed at ensuring banks have the resources on hand to get through unexpected losses, shoring up confidence that banks could withstand a worsening of Europe's financial troubles or another economic downturn.

Some banks, notably in Ireland, which passed last year's tests ended up requiring government help to survive.

The current debt crisis among European governments is viewed in part as a banking crisis as well, since government bonds are widely held by banks and market losses, or a default, would hit their finances.

So far, Greece and Ireland have had to be bailed out to avoid defaulting on bonds. Portugal asked the European Union on Wednesday for a bailout after its shaky finances led bond markets to refuse to lend it more money at affordable rates.

Additionally, collapsed real estate markets in several countries have caused bank losses on real estate loans that in turn hit governments in the form of bailout costs. The high cost of Ireland's banking cleanup is largely what drove its government to the brink of bankruptcy.

This time banks will have to keep core Tier 1 assets amounting to at least 5 percent of the loans, bonds and other investments that they hold. That's tougher than the regulatory minimum for EU banks.

The core Tier 1 standard has drawn opposition from banks in Germany, since it tends to exclude silent participations, a kind of non-voting holding that is counted as core capital in Germany.

German officials say excluding silent holdings unfairly puts some of the country's banks at risk of looking bad under the tests -- particularly public-sector regional banks known as Landesbanken, where silent holdings are common.

The Association of German Banks said it was "not appropriate" to use the stricter standard ahead of its introduction under the international Basel III agreement, which will be introduced gradually between 2013 and 2018.

"The test will certainly supply valuable information about whether the banking system is fundamentally stress resistant, but it will not permit conclusions about whether an individual bank has a sustainable business model," the association said in a statement.

Banks will be subjected to a scenario in which Europe's economy shrinks 0.4 percent this year and does not grow at all next year -- 4 percentage points below current estimates.

If the stress scenario shows their capital ratio falling below 5 percent, they would be expected to take remedial action, such as raising more capital by issuing shares to investors or reducing the size of their business.

Last year's test included only a 3 percent drop below growth expectations.

The list of 90 banks to be tested makes up 65 percent of the European banking system, and includes all the banks that were in last year's test except for those that no longer exist independently.

Banks that were added are Austria's Oesterreichische Volksbank AG, Denmark's Nykredit, Ireland's Irish Life and Permanent, Norway's DnB NOR Bank ASA, and Slovenia's Nova Kreditna Bank Maribor D.D.

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