ECB Said to Use 8% Capital Buffer on Biggest Banks

The European Central Bank will require the euro area’s biggest banks to hold a capital buffer of at least 8 percent as it takes charge of financial supervision in the currency bloc, three people familiar with the situation said.

The ECB will ask banks to hold capital equivalent to 7 percent of risk-weighted assets, plus a supplemental 1 percent for the largest institutions, said the people who declined to be identified as the details are confidential. An ECB spokeswoman declined to comment. The central bank is scheduled to publish further details at 9 a.m. in Frankfurt today.

“That’s a level many banks could cope with,” Dirk Becker, a banking analyst with Kepler Cheuvreux in Frankfurt, said in an interview. “Banks will continue to set aside profit as ECB supervision nears. I don’t see a whole lot of share sales, as it is pretty tough to justify issuance.”

The ECB is taking charge of bank oversight as policy makers try to prevent a rerun of a debt crisis that was partly sparked by banks’ overexposure to sovereign debt. The first step will be to run tests on the balance sheets of 124 banks from Deutsche Bank AG, Germany’s biggest bank, to the Estonian unit of Norway’s DNB ASA. The operation may force some lenders to seek more capital.

Lowest Number

A key determinant of how much banks will have to raise will rest on how the ECB measures the riskiness of bank assets, guidelines the ECB hasn’t yet published and which may differ from how banks currently gauge it. That makes it difficult to calculate which banks may fall foul of the ECB’s capital ratio.

Under current Basel III standards, the weakest of the 19 large banks monitored by Bloomberg Industries still have ratios above 8 percent. Commerzbank AG, which had the lowest number among the euro region banks, had a ratio of 8.4 percent.

“The ratio is just the starting point, more will depend on the stress test that is applied on top of them and what happens to the capital ratios then,” said Cor Kluis, an analyst at Rabobank International, covering Dutch and Belgian banks. “What will help increase safety of the European banking system is a consistent cross-border view and definitions, which is what we didn’t have so far.”

The benchmarks planned by the ECB effectively bring forward a European Union standard on the capital ratio that was not due to fully take effect until 2019. The definition of capital in EU rules will toughen year by year through 2019 as currently foreseen, one of the people said.

Three-Pronged Assessment

The ECB is cooperating with the European Banking Authority in a three-pronged assessment of the continent’s financial industry.

The ECB will execute a preliminary risk check early next year to identify asset portfolios needing further examination, followed by a full review of the quality of banks’ overall balance sheets. The EBA will then help conduct a stress test in the course of 2014 that will study how banks might withstand bouts of market turmoil as well as an assessment of their sovereign debt holdings.

The 8 percent capital ratio demanded by the ECB is lower than the average held by financial institutions around the world when Basel III standards are used.

‘Full Visibility’

The ECB’s 8 percent threshold consists of a 4.5 percent common equity tier 1 capital minimum, up from 2 percent under current EU rules. On top of that is a 2.5 percent capital conservation buffer. One additional percentage point of capital against assets would then be required for banks large or complex enough to endanger the whole financial system if they fail.

“The main aim of the asset review is to allow the ECB to gain full visibility on the quality of the assets of the banks which will be under its direct supervision,” said Marco Valli, chief euro-area economist at UniCredit Global Research in Milan. “The lack of balance sheet visibility and comparability across countries has been one of the main factors weighing negatively on investors’ perception of the riskiness of the European banking industry.”

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