ECONOMY

ECB says capital definition stricter in stress test than review

The European Central Bank said the definition of capital it uses to stress test banks will be stricter than the one in an imminent review of their assets, as it confirmed that lenders will be required to have a capital ratio of 8 percent.

The capital definition applicable on January 1, 2014 will be used for the asset-quality review, while the definition valid “at the end of the horizon” of the stress test will be used in that evaluation, the Frankfurt-based central bank said in an e- mailed statement today. The ECB will commence its study in November and conclude the three-part exercise in October 2014 before assuming supervisory powers over the region’s banks. The European Union is scheduled to fully implement global capital rules by 2019.

European officials have entrusted the ECB with overseeing the region’s financial system to prevent a repeat of the turmoil that set off the euro area’s worst recession since World War II. Expanding its mandate from setting monetary policy to direct oversight in 2014 is the most significant revamp in the institution’s 15-year history, and risks putting its reputation on the line as guardian of the euro.

“A single comprehensive assessment, uniformly applied to all significant banks, accounting for about 85 percent of the euro-area banking system, is an important step forward for Europe and for the future of the euro-area economy,” ECB President Mario Draghi said in the statement. “Transparency will be its primary objective. We expect that this assessment will strengthen private-sector confidence in the soundness of euro-area banks and in the quality of their balance sheets.”

Capital Ratio

Ignazio Angeloni, head of the ECB’s financial stability directorate, will hold a press conference at 10 a.m. in Frankfurt.

The ECB said the 8 percent capital requirement will include a common equity tier 1 ratio of 4.5 percent. On top of that is a 2.5 percent capital conservation buffer and a 1 percent add-on “to take into account the systemic relevance of the banks considered significant.”

The definition of capital will become stricter as rules converge to the Basel III requirements.

The ECB will execute a preliminary risk check early next year to identify asset portfolios needing further examination, followed by a full review of the quality of banks’ balance sheets. The European Banking Authority will then help conduct a stress test in the course of 2014 as well as an assessment of their sovereign debt holdings.

Stress Test

The two institutions “will agree on, and communicate, further details on the stress test, the methodology and the scenarios to be used and the correspondent capital thresholds in due course,” the ECB said. It will “soon” convene meetings in Frankfurt with the banks that will undergo the comprehensive assessment.

The ECB identified 124 banks, which may be subject to the balance-sheet exam on the basis of data as of the end of 2012. The final list will only be compiled in 2014.

National regulators will run the exercise at the country level, on the basis of centrally developed data requirements and methodology, the ECB said.

At the end of the assessment, the ECB will publish aggregate data at country and bank level, together with any recommendations for supervisory measures, the ECB said. The evaluation will be published prior to the ECB assuming its supervisory role in November 2014, it said.

Enhanced Backstops

While today’s announcement offers details of the ECB’s plan on how it will fulfill its supervisory tasks, EU officials are still squabbling over whether enhanced backstops should be put in place to fill capital shortfalls the ECB might identify.

Dutch Finance Minister Jeroen Dijsselbloem has touted indirect recapitalization from the euro-area firewall fund and direct aid to banks in “exceptional circumstances” as credible backstops. Germany’s Wolfgang Schaeuble said last week in Luxembourg that direct bank aid from the European Stability Mechanism would require changes to German law.

ECB President Mario Draghi said on Oct. 2 that it “astonishes” him that doubts have arisen over whether national backstops will be in place by the time the ECB starts supervision. “There is an explicit assurance about this,” he said.

[Bloomberg]