Q+A – How Europe will stress-test its banks

BRUSSELS, July 5 (BestGrowthStock) – In an effort to reassure
financial markets about the health of the European Union’s
banking system, the bloc’s countries will stress-test a large
number of their banks and publish the results. [ID:nLDE6601T6]

WHICH BANKS WILL BE TESTED?

Originally, EU regulators planned to test just 25 large,
cross-border banks, including Germany’s Deutsche Bank (DBKGn.DE: )
and Commerzbank (CBKG.DE: ), France’s BNP Paribas (BNPP.PA: ) and
Credit Agricole (CAGR.PA: ), and Britain’s Royal Bank of Scotland
(RBS.L: ), HSBC (HSBA.L: ), Barclays (BARC.L: ) and Lloyds (LLOY.L: ).

But the EU executive and the European Central Bank pressed
countries for a major increase in the number of banks, and a
total of around 100 or more is now likely to be tested. A
comprehensive list has not yet been released.

The tests are expected to cover banks holding about half or
more of banking assets in each country. This could mean, for
example, that Germany tests 15 banks instead of the three
originally planned.

The expanded tests will probably include most or all of
Germany’s eight regional landesbanks, and some of Spain’s 45
cajas, which are unlisted savings banks.

HOW WILL THE TESTS WORK?

National supervisors, such as Germany’s Bafin, will carry
out the tests, which will be coordinated by the Committee of
European Banking Supervisors, a London-based umbrella group for
financial supervisors.

The tests will simulate how banks cope with financial
pressures on their loans and other assets in a worsening
recession. Results are expected to be released for individual
banks, although the degree of public disclosure remains unclear.

European countries decide on the scenarios to be used in
testing, under the supervision of the ECB and the EU executive.
Many details of the scenarios have not be announced, partly
since they seem still to be under discussion for smaller banks.

The European Commission wants a “sovereign debt shock” to be
among the scenarios that are tested; this could include the
failure of a country such as Greece to repay debts. Countries
such as Germany have been reluctant to put their banks through
extremely harsh scenarios.

Banks will be tested on how their so-called Tier 1 capital,
a key measure of financial strength, bears up. The ECB wants to
see if the ratio of this capital to assets stays above a minimum
benchmark of 6 percent of assets in the tests; although this is
higher than the 4 percent legal minimum, it is lower than most
bank shareholders are happy with. Deutsche Bank, for example,
now has more than 11 percent.

WHEN WILL THE RESULTS BE RELEASED?

The outcome of the tests will be published around July 23,
French Economy Minister Christine Lagarde said on Sunday.

WHAT ARE THE TESTS LIKELY TO SHOW?

Testing of the original 25 big banks appears already to have
been completed, and the results are not expected to reveal
serious problems; these banks have generally strengthened
themselves since the global financial crisis of 2007-2009, and
have retained their ability to raise funds from the private
money markets. German sources told Reuters that Deutsche Bank,
Commerzbank and BayernLB [BAYLB.UL] had “passed” the tests.

There is much more concern about the possibility of serious
balance sheet weaknesses being discovered among smaller, second-
and third-tier banks, such as the landesbanks and the cajas. Few
believe the state owners of Germany’s landesbanks, for example,
have revealed the full extent of their problems.

Many banks in Greece and Portugal have largely lost access
to the private markets during their countries’ sovereign debt
crises, and are surviving on funding from the ECB.

However, officials from the ECB and EU governments have
insisted that the stress tests will show the European banking
system is fundamentally healthy. Lagarde said, “You will see
that banks in Europe are solid and healthy.”

WILL THEY REASSURE MARKETS?

Limited stress tests of a small number of European banks
last year, the results of which were not released for individual
institutions, failed to reassure the markets.

This time, the tests are likely to appear closer in scope,
rigour and transparency to stress tests of U.S. banks undertaken
during the global crisis. Those tests did succeed to some degree
in easing investor worries.

However, there is a danger that if the scenarios appear too
soft on the banks, or if only partial results are made public,
investors could view the tests merely as attempts to manipulate
market opinion and hide deep-seated problems. In that case, the
tests could actually increase market jitters.

Once the results are out, investors will want to see that
national governments are willing and able to act quickly to
resolve any problems that have been uncovered.

ECB officials have urged countries to make sure they have
emergency financial safety nets in place to prevent any
disorderly failures of banks that fail to meet the 6 percent
capital benchmark in the tests. Governments say they have
already created these safety nets or are willing to take further
action to protect their financial systems if necessary.

Spain, for example, set up its Fund for Orderly Bank
Restructuring a year ago; it has initial capital of 9 billion
euros and can theoretically borrow another 90 billion euros in
debt markets with a state guarantee.

If a German bank fails to pass tests, the Bundesbank will ask
it to access the capital markets or obtain funds from Germany’s
rescue fund Soffin, which still has 300 billion euros in funds,
German financial sources have said.

Under an agreement with the International Monetary Fund, the
Greek government has been preparing legislation to create a 10
billion euro support mechanism for banks in case their capital
adequacy falls and they are unable to raise funds from markets.

Given the complexities and uncertainties in bank balance
sheets, it is possible that the markets will not be entirely
reassured until economies around Europe return to strong,
self-sustaining growth — a process that could take one or two
years in the region’s weak southern periphery.

(Writing by John O’Donnell; Editing by Andrew Torchia)

Q+A – How Europe will stress-test its banks