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ECB: first euro area bank 'stress tests' a "major milestone" ahead of new regulatory regime

Out-Law News | 28 Oct 2014 | 3:39 pm | 2 min. read

Roughly one in five of the EU's largest banks were not holding enough capital to cover the impact of market 'stress' as of the end of 2013, although 12 of the affected 25 have since taken action to rectify the shortfall, according to the European Central Bank (ECB).

The ECB, which will become the single supervisor of banks in the eurozone from next month, found a capital shortfall of €25 billion at 25 of the largest 130 banks of which it will have oversight. It said that the 13 banks with capital shortfalls would have to prepare plans to cover the shortfall within two weeks, and would have up to nine months in which to raise the necessary funds.

"This unique and rigorous exercise is a major milestone in the preparation for the Single Supervisory Mechanism (SSM), which will become fully operational in November," said ECB vice-president Vitor Constâncio.

"This unprecedented in-depth review of the largest banks' positions will boost public confidence in the banking sector. By identifying problems and risks, it will help repair balance sheets and make the banks more resilient and robust. This should facilitate more lending in Europe, which will help economic growth," he said.

The SSM was established by EU leaders in response to the 2008 global financial crisis, as a means of increasing financial stability and integration in the eurozone by harmonising supervisory practices. The ECB will take over the direct supervision of the 130 largest financial institutions operating in the Eurozone, accounting for 82% of total banking assets in the eurozone, and will work with national competent authorities to oversee smaller banks.

In preparation for the transfer, the ECB conducted a year-long "comprehensive assessment" of the banks it will supervise which consisted of two parts. First, an asset quality review (AQR) was carried out in order to assess whether banks, regardless of where they were based, were assigning different types of asset the same value on their balance sheets. Secondly, 'stress tests' were carried out to assess the ability of participating banks to withstand economic shocks.

As part of the AQR, the ECB and national competent authorities analysed more than 800 individual loan portfolios containing 119,000 borrowers. They found that banks had been valuing their loans and assets at around €48bn more than they were really worth, primarily because they had not properly reflected the value of €136bn of 'bad' loans on their balance sheets. Of the total reduction, €11bn affected banks that also failed the stress tests. Affected banks will be expected to account for the difference in their updated accounts and prudential requirements.

The stress tests, which were carried out in conjunction with the European Banking Authority (EBA), subjected banks to a series of financial scenarios designed to establish their financial resilience such as falling house prices or national GDP. In order to pass, banks had to be able to maintain a capital ratio of 8% dropping to 5.5% during the most stressed scenarios. The assessment showed that a severe scenario would reduce banks' top quality capital by a total of about €263bn. The worst affected banks were located in Italy, Greece, Cyprus, Belgium and Slovenia.

Danièle Nouy, chair of the SSM supervisory board, said that the exercise "exposed the areas in the banks and the system that need improvement", and would allow the ECB to "draw insights and conclusions for supervision going forward".