The European Central Bank’s probe into the health of Europe’s banks will be more credible than previous exercises because the institution itself will have to deal with the outcome, the official overseeing the test said.
“Whatever conclusions and the follow-up actions that are indicated will be monitored and checked and enforced by the supervisor,” ECB Director General for Financial Stability, Ignazio Angeloni, said at a press conference in Frankfurt today. The fact that the ECB can combine an asset review and a stress test is “a fundamental strength,” he said.
The ECB released details of a three-stage asset review, which it is running as a condition for taking over supervision of lenders ranging from Deutsche Bank AG to Malta’s Bank of Valletta Plc. As part of Europe’s attempt to sever the link between fragile banks and debt-laden states, the institution set a threshold of 8 percent of capital to assets at those lenders.
“I expect this to be a tough exercise,” Thomas Harjes, an economist at Barclays Plc, said in an interview on Bloomberg Television. “This time the ECB can really go into these banks and really look very carefully at loan books and so on.”
ECB Executive Board member Joerg Asmussen said this month that “this is our third and last chance to restore confidence” after two previous stress tests by the European Banking Authority failed to do so.
The euro fell after the ECB’s report was published today and traded at $1.3752 at 1:39 p.m. in Frankfurt. The Stoxx 600 financial services index dropped more than 0.8 percent to 325.87.
“The asset-quality review and the stress test are obviously not about letting banks fail, but providing more clarity and confidence,” said Marco Valli, chief euro-area economist at UniCredit Global Research in Milan. “This may allow for some flexibility which will help avoid some of the problems that emerged after the EBA stress test in 2011.”
The ECB’s so-called Comprehensive Assessment will start in November and conclude next October. Officials will execute a preliminary risk check early next year to identify asset portfolios needing further examination, followed by a full review of balance sheets. The EBA will then help conduct a stress test and an assessment of banks’ sovereign debt holdings.
“Rigor and transparency from the ECB will be important for credibility of the exercise,” Anatoli Annenkov and Michel Martinez, economists at Societe Generale SA, said in a note to clients. It is “a potential game changer in the broader context of building a European banking union,” they said.
The ECB will use stricter rules when stress-testing banks’ balance sheets than it will to study their assets. For the 8 percent ratio, the capital definition in force on Jan. 1, 2014 will be applied for the asset-quality review. The definition in use “at the end of the horizon” factored into the stress test will be employed in that evaluation, the ECB said.
Angeloni said officials haven’t yet decided on a timeframe or on details of the stress test. The European Union is gradually phasing in global capital standards known as Basel III, a process which will make them stricter over time and which is due to be completed by 2019.
‘Feasible But Safe’
“We’ve got a feasible but safe capital cushion of 8 percent,” Angeloni told reporters. “We want the exercise to encompass all the main sources of risk.”
As the stress test and asset-review will use different capital bases, Angeloni added that the whole exercise will produce one “distilled” assessment of banks’ capital needs at the end of the process in October next year, rather than a sequence of individual estimates.
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,” ECB President Mario Draghi said in a statement today. “Transparency will be its primary objective.”
The ECB’s 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,” it said.
The ECB’s methodology “is a good calibration,” Nordea Bank Chief Executive Officer and European Banking Federation President Christian Clausen said in an interview in Stockholm today. “If we get the banking sector there after there is a quality review, then I think we can see very good progress in the European banking sector.”
The ECB and the EBA “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 institution said. The evaluation will be published prior to the ECB assuming its supervisory role in November 2014, it said.
If capital shortfalls are identified, banks will be required to adopt “corrective measures,” the ECB said, adding that it will be able to monitor and enforce the implementation of those measures in its new capacity as supervisor.
“While the release provides much-needed information, it still leaves many questions open, including the exact division of labor between the ECB, national authorities, and third-party consultants, precise valuation approaches, the stress test methodology and assumptions, and the all-important question of what the backstops would be,” economists at Citigroup Global Markets Inc. including Ebrahim Rahbari said in an e-mailed note to clients.