Global Crisis

New European Banking Regulator Will Conduct a Stress Test on Lenders

Posted on Saturday, January 15, 2011

PARIS — The European banking regulator said on Thursday that it would conduct another round of stress tests on lenders this spring, a move that investors hope will offer more clarity on the health of balance sheets than previous exercises.
Also Thursday, a panel of international regulators said that it would require a broader range of securities holders to assume some of the cost if a bank failed.
The European stress tests will be the third such exercise conducted by the region’s regulators during the crisis. The regulator, the European Banking Authority, which was formed at the start of this year, said the tests would take place in the first half of 2011, with results expected in mid-2011.
The results of the last tests, published in July, were received with skepticism by critics who argued that they did not reveal the full extent of banks’ troubled assets, notably sovereign debt exposure. Those tests focused on the trading book, a bank’s liquid portfolio of securities, rather than the banking book, where assets are typically held to maturity.
“If they again come up with something that is manifestly fudged, it won’t impress anyone,” said Graham Bishop, an independent European financial services analyst. By the time the results are published, he said, European policy makers will have had to either substantially expand their financial support mechanisms for countries or move to restructure banking debts. He said he expected the former, which would represent a major step toward fiscal integration of the euro zone.
Last year, seven of 91 banks failed the tests — including Hypo Real Estate in Germany, the Agricultural Bank of Greece and the Diada Savings Bank of Spain. To pass, a bank’s Tier 1 capital, a measure of core capital including common equity and retained earnings, had to remain at or above 6 percent of assets in the face of a new recession and debt crisis.
But since then, Ireland has been required to turn to outside lenders as its banks have required more capital, and large question marks remain over the holdings of some Spanish lenders.
Madrid has lent its banks about 10.6 billion euros ($14.2 billion), which represents about 1 percent of gross domestic product. Citigroup estimates that Spanish banks are carrying about 150 billion euros in undeclared losses.
The European regulator said that the tests, which will be carried out in cooperation with national supervisors, the European Central Bank and the European Commission, would “cover a broadly similar group of banks as last year.” It added, “The methodology and approach taken will build on that used in the 2010 stress test.”
European finance officials met in Brussels this week and discussed the new tests. An official present, who was not permitted to speak publicly, said the process would start in March and results would be published in June. But he said the exact parameters — notably whether to include data on the banking book — had yet to be settled.
Meanwhile, the international regulators — the Basel Committee of the Bank for International Settlements — said that starting in 2013, “all classes of capital instruments,” rather than just stockholders, should fully absorb losses in the event of a bank crisis before taxpayers are exposed to losses.
“This is a pretty big development,” said Christopher Bates, a partner specializing in financial services at Clifford Chance in London. “It’s intended to facilitate the restructuring of bank debt without public money, while keeping struggling banks alive as going concerns.”
During 2008 and 2009, a number of distressed banks were rescued by states injecting funds in the form of common equity and other high quality, of Tier 1, capital. While this supported depositors, it also meant that Tier 2 capital instruments, mainly subordinated debt, “did not absorb losses incurred by certain large internationally active banks that would have failed had the public sector not provided support,” the committee said.
With several exceptions, all new noncommon Tier 1 and Tier 2 securities issued by international banks must include the option starting in 2013 of either being written off or converted into common equity.
Securities issued before that date, and that do not meet the rules, will need to be progressively phased out of banks’ capital between 2013 and 2023. The rules will need to be imposed by national legislators before going into effect.
“It affects a swath of instruments that were relied on by banks for supplementing their capital, which will have to be replaced by new debt with more demanding requirements,” Mr. Bates said.
By MATTHEW SALTMARSH, THE NEW YORK TIMES


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