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Banks should raise capital now to guard against European Central Bank stress tests, says ECB vice president

Out-Law News | 28 Apr 2014 | 3:12 pm | 2 min. read

European banks should take advantage of favourable market conditions to raise capital before the European Single Resolution Mechanism (SRM) takes effect, the vice president of the European Central Bank (ECB) has said, according to the Financial Times.

Vítor Constâncio described as "reassuring" the level of money investors are currently investing in banks in the EU, as the financial institutions prepare themselves for ECB stress tests this summer.

Under new EU legislation, the ECB will become the single regulator of the largest banks in Europe from November this year. Ahead of taking up its new responsibilities, the ECB is conducting a 'comprehensive assessment' of the banks, to gain a clearer picture of their financial health. As part of the assessment, the ECB will subject the banks to stress tests - hypothetical financial scenarios designed to establish their financial resilience. Under the new measures, a new European authority will have the power to restructure or wind up failing banks and a €55 billion bail-in fund is to be established, funded by levies on banks, and designed to prevent tax payers having to foot the bill failures.

According to Morgan Stanley, the multinational financial services advisor, euro zone banks have raised €30bn since the ECB announced its comprehensive assessment, the Financial Times said.

“Hopefully, this situation will remain unchanged until November so that banks that need to reinforce their capital buffers will be able to raise money in the private market and the whole question of public backstops can move to the background,” Constâncio told a conference in Madrid.

However Constâncio urged banks to study carefully the new EU resolution mechanism legislation which would allow failing banks to be put into resolution and, if necessary, wound up. “Very likely, if such bank is formally put into resolution it may suffer irreparable damage in the market place, further complicating its situation and generating spill over effects on other banks," he said.

However Constâncio suggested that exemptions to the new resolution rules might apply if necessary, to avoid a “serious disturbance” in an EU member state’s economy and preserve financial stability. “We certainly hope that in the context of such a wide-ranging undertaking to assess the robustness and resilience of European banks, there will be reasonable financial stability aspects to justify, in several cases, such exemption,” he added.

The ECB is due to publish parameters of the forthcoming bank stress tests this week.

In February the ECB said that in order to pass the tests, banks will need to be able to maintain a capital ratio of 8%, dropping to 5.5% during the most stressed scenarios. The test will be based on a 'static' balance sheet, meaning it will assume no growth or risk management actions, such as planned asset sales, during the period being tested. National supervisors can choose to include additional risks or higher capital thresholds as part of the test, but these will have to be published separately so that the results of the tests can be interpreted consistently.