European regulators will scrutinise banks’ calculations for losses on sovereign debt held to maturity when carrying out this year’s stress tests, Europe’s top banking supervisor said.
Financial watchdogs will “check what banks are doing with reference to some sovereign exposures and see whether they’re taking a conservative attitude” when valuing the assets, Andrea Enria, the chairman of the European Banking Authority, said in an interview in London.
Ninety banks will be expected to maintain a Core Tier 1 capital ratio of at least five per cent under the stress-test scenarios, the EBA said. Portugal last week became the third euro-area state after Greece and Ireland to succumb to the region’s sovereign-debt crisis and request emergency aid.
“I understand on contacts I’ve had with banks that some of them have already reviewed the valuations of sovereign exposures on the banking book towards certain countries,” Enria said. Banks hold on to bonds in the banking book until the principal is scheduled to be repaid, rather than trading them on the secondary market.
This year’s tests will include a review of how banks would handle a 0.5 per cent economic contraction in the euro area in 2011 as well as a 15 per cent drop in European equity markets.
The EBA tests will also examine the effect of a 75 basis- point-jump in interest rates on European sovereign bonds and an increase in short-term inter-bank financing costs of 125 basis points.
‘Weaknesses’
Banks that fail the stress tests will have until the end of the year to complete plans to recapitalise or restructure their business, Enria said.
If an institution is found to have “weaknesses in terms of its risk modeling, you intervene as a supervisor, you must act,” Enria said. “This isn’t less important to us than raising capital.”
Enria said lenders with flawed risk models that pass the exams may also be required to address EBA questions. “Guess what, given all the accountants and lawyers in the room, you can game a static capital buffer,” James Babicz, head of risk at business analytics company SAS UK, said in a telephone interview. “Risk is unmeasurable by its definition.”
Enria said he may allow some banks more time to submit results because lenders will be measured against stricter capital standards than last year. The EBA will aim to publish the results of the exams at the end of June.
Submission Deadline
Germany’s Bundesbank and financial regulator BaFin called for the stress-test information submission deadline to be extended by two weeks. The original deadline was the end of April.
“If some banks cannot manage, then we’ll be flexible in terms of deadlines,” Enria said.
Regional German banks, including Norddeutsche Landesbank and Landesbank Hessen-Thueringen, have complained that the EBA’s tighter definition of capital may lead to some lenders failing the exams.
Lenders won’t be allowed to use some types of non-voting capital permitted by German bank supervisors, known as silent participations, to calculate the results.
“There are a lot of other instruments in the capital of European banks in other countries that got less attention but have exactly the same features,” Enria said. “There will be pain for banks in almost all countries.”
At least five banks were added to the list of those examined last year. Ireland’s Irish Life and Permanent Plc, Norway’s DnB NOR Bank ASA, Nykredit Bank from Denmark, Slovenia’s Nova Kreditna Banka Maribor and Oesterreichische Volksbank AG from Austria will be tested for the first time.
Core Tier 1, as defined by global regulators in the Basel Committee on Banking Supervision, largely consists of banks common stock and retained earnings. The 2010 tests were conducted against a pass rate of six per cent Tier 1 capital, which encompasses a broader range of securities including hybrid instruments such as preference shares.
