Thursday, July 8, 2010

EU Sets Stress-Test Criteria; Results Due July 23

BRUSSELS—Stress tests being carried out on European Union's largest banks will cover 91 banks and 65% of the region's banking assets, regulators said Wednesday as they released the first details of the exercise now under way.

The tests will examine how heavy losses at European banks would be if European economies pitch back into recession and in the face of a "sovereign shock" that would generate losses on banks' government bond portfolios.

According to a statement from Committee of European Banking Supervisors, the London-based body that groups the EU's national authorities, the tests' will examine an "adverse scenario" in which European growth is 3 percentage points of GDP slower than current EU forecasts over the next two years.

"The objective of the extended stress test exercise is to assess the overall resilience of the EU banking sector and the banks' ability to absorb further possible shocks on credit and market risks, including sovereign risks, and to assess the current dependence on public support measures," the statement says.

The latest forecasts from the European Commission suggest growth in the 16-nation euro zone will be 0.9% this year and 1.5% in 2011, while the forecasts for the 27-nation EU as a whole suggest a moderately faster expansion of 1.0% and 1.7%.
European governments are hoping the stress tests will settle uncertainty about the health of Europe's banks that have been heightened by the fallout from Greece's debt crisis. Banks remain highly dependent on funds provided by the European Central Bank.

Last year, stress tests carried out in the U.S. were widely credited with helping to turn the corner in following the 2007-08 financial crisis.

Results of the tests, both in aggregate and on a bank-by-bank basis, will be released July 23.

To settle uncertainty, analysts say the tests needed to be credible and transparent-and to be followed up by plans to recapitalize banks whose capital cushions fall short.

However, the agency didn't release much detail about the tests, even what it would regard as a satisfactory minimum capital base for banks.

Neither was there much detail about the nature of the sovereign shock to be tested—though the statement said it would be worse than that prevailing in government bond markets in early May. That was before a program began under which the European Central Bank has started buying euro-zone government bonds.

There had been some concerns that the tests would assume a uniform economic condition across the EU. Wednesday's statement made clear, however, that GDP, unemployment and inflation would be differentiated on a country-by-country basis.

European leaders decided late last month to expand continuing stress tests of its 25 biggest banks to include second-tier banks such as German regional banks and Spanish savings banks, the Landesbanken and cajas. The aim was to give an idea of national as well as EU-wide resilience to any further financial or economic troubles. The tests cover at least half of banking assets in each EU country.

European officials had said more than 100 banks would be tested. The reason for the discrepancy in numbers is that the 91 figure assumes mergers under way that will reduce the number of Spanish cajas by more than 20 have already taken place.

Analysts at Morgan Stanley said in a note this week that for the tests to work they need to be transparent and tough enough to be credible. Governments must also show they have plans in place to boost banks' capital if needed. Many European banks don't rely on stock markets for capital, but are owned by regional governments, cooperatives and mutual associations, so raising funds can be difficult without government help.

Write to Stephen Fidler at and Carolyn Henson at