ECB promises upcoming stress tests for European banks to be tougher

The European Central Bank’s upcoming check of European bank balance sheets will cast “three pairs of eyes” over lenders’ books to ensure credibility, Executive Board member Benoit Coeure said.

“The way we will do it next year will be very different from the way that the previous two stress tests were done,” Coeure said at an event in Washington yesterday. “Any number provided by the banks will first be checked by the national supervisor, then there will be a second check at the European level, in Frankfurt. And then there will be a third check by independent auditors.”

The Frankfurt-based ECB is taking over supervision of Europe’s lenders as part of a banking union that seeks to prevent a repeat of the financial turmoil caused by the sovereign debt crisis. Before they assume responsibility next year, the ECB will perform a three-stage health check on the system that culminates with a test simulating stress scenarios.

The balance-sheet assessment preceding the stress tests will be “a way to dispel the notion that assets are worth much less than what you can see,” Coeure said. “For that you need clarity.”

European lenders have had to undergo two stress tests since 2010, with eight banks failing the last round conducted by the European Banking Authority in 2011 with a combined capital shortfall of 2.5 billion euros ($3.4 billion). ECB officials have said the central bank shouldn’t take over supervising lenders before bad loans on balance sheets across the region are dealt with.

The ECB has pushed national governments to have money ready when the results of the exercise are ready next year, if banks can’t raise private capital themselves when shortfalls are found. Coeure said the European Stability Mechanism, a bailout fund, should be ready if states need assistance, a move which would require governments to enter a formal aid program monitored by European partners.

“What should be at least available is European support to countries in the form of ESM lending, the way it has been done in Spain,” Coeure said. “This works. It has been used in Spain, so we know that it works. We also have to be sure this comes after all other stakeholders have been involved, meaning shareholders should be wiped out and there has to be a certain amount of bail in also.”

“Some banks may have to raise capital,” President Mario Draghi said in New York on Oct. 10. Still, “from what we see today the situation is not bad. In the last month and a half we’ve seen several banks capable of raising capital. So the market prospects are way better than they were on the occasion of the last stress tests two years ago.”

Draghi will present the methodology for the ECB’s bank assessment on Oct. 23, Executive Board member Yves Mersch said in an interview with the Frankfurter Allgemeine Zeitung published yesterday. The ECB will require the 130 largest banks that it supervises directly to hold higher levels of capital than they do now because of their systemic relevance, Mersch was reported as saying.

Banks in Spain, Italy and Portugal face about 250 billion euros ($338 billion) in potential losses on their business loans over the next two years, the International Monetary Fund said on Oct. 9, with about one fifth of combined corporate loans in the three countries at risk of default. Bank lending overall in the 17-nation euro area has contracted for the past 16 months.

The Governing Council of the ECB, the central bank’s highest decision-making body, may vote this week on how it will proceed with the assessment. Officials have said so far that an assessment to identify the riskiest portfolios will come first, followed by an asset-quality review, and then stress tests.

“European banks are not loaded with toxic assets, they are loaded with assets and loans that were granted at a time when they were profitable, and that are not so profitable anymore because the environment has changed,” Coeure said. “If we want banks to be able to accompany the recovery, they have to be able to structure their balance sheets in a way that creates room to extend new loans.”


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