European Bank Stress Tests Need Rethink, Elderfield Says

Twenty percent of Europe’s biggest banks would have failed to meet global capital standards, known as Basel III, as of June 2011, the European Banking Authority said in an impact assessment of the planned rules.

About a fifth of the 48 largest banks in the study would have had a core tier 1 capital ratio below 4.5 percent, the absolute minimum allowed under Basel III guidelines, the EBA said in a report published on its website today. Half of those would have needed to raise a combined 242 billion euros ($318 billion) to reach a 7 percent ratio, the minimum for internationally active banks, according to the report, based on June data.

“Given these results, a significant effort by banks to fulfill the risk-based capital requirements is expected,” the EBA, the region’s top banking regulator, said.

Global regulators at the Basel Committee on Banking Supervision have clashed with banks over the severity of the overhaul of capital and liquidity rules, known as Basel III, that was designed to prevent a rerun of the crisis that cascaded across financial markets after the collapse of Lehman Brothers Holdings Inc. in 2008.

Costs ‘Underestimated’

“The authorities have underestimated the cost and difficulty for the banks in meeting the higher Basel III requirements,” Patricia Jackson, head of prudential advisory at Ernst & Young LLP in London, said in an e-mail.

“The 7 percent quoted by the EBA is only part of the story,” she said, as “large systemic banks” are required by the Basel rules to hold additional capital. “Some banks are targeting 12 percent or even higher” to make a buffer before they breach their requirements, Jackson said.

The Basel group agreed in 2010 to more than triple the core capital that lenders must hold, as well to make them hold minimum stocks of easy-to-sell assets. Core tier 1 capital is a measure of high-quality, loss-absorbing, reserves that banks have to hold against risky assets. The rules are scheduled to be phased in by 2019.

Banks plan to raise about 98 billion euros in new capital by the end of June this year to meet the demands of an EBA exercise to protect against the region’s sovereign-debt crisis, the regulator said in February.

“The situation has changed a lot” since June last year, said Karel Lannoo, chief executive officer of the Centre for European Policy Studies, a Brussels-based research institute. One major change is the European Central Bank’s provision of more than a trillion euros of three-year low-interest loans to lenders, Lannoo said in a phone interview.

Liquidity Shortfall

The banks surveyed by the EBA collectively have a shortfall of approximately 1.2 trillion euros in the easy-to-sell assets they need to meet the Basel rule, known as a liquidity coverage ratio, or LCR.

The Basel measures also include another liquidity rule, known as a net stable funding ratio or NSFR, which would force banks to back long term lending with sources, such as term deposits, that are unlikely to dry up in a crisis.

Lenders had a shortfall in June of about 1.9 trillion euros in the stable funds needed to comply with the requirement, the EBA said.

The NSFR is still a “big problem for a lot of banks,” Lannoo said.

The EBA studied 158 banks for the Basel III impact assessment. Of this total, one bank didn’t offer enough data to be measured against the LCR benchmark. Two lenders didn’t provide enough information on their NSFR level.

European Union and Basel regulators are preparing changes to the liquidity rules to prevent unintended consequences.

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