EUROPEAN REGULATORS will apply stricter capital rules in its next round of bank stress tests, but the European Banking Authority (EBA) has yet to agree on an exact “pass” mark for financial institutions.
The EBA said yesterday that the stress tests it is due to undertake between March and June will take into account the possibility of more severe adverse economic scenarios than the failed 2010 tests.
It confirmed that this year’s tests would be based on “core” Tier 1 capital, a benchmark that comprises shareholders’ capital and retained earnings.
Last year’s stress tests, conducted by the EBA’s predecessor, the Committee of European Banking Supervisors (CEBS), used the less strict Tier 1 threshold.
This is a broad measure of a bank’s resilience, but lenders can pad out this type of capital with lower quality assets that obscure how much cash is available to the bank.
The EBA has not yet said which banks it will include in the 2011 stress tests, which will be carried out on a sample of about 90 European banks covering more than 65 per cent of total EU banking assets.
In a statement, it also said it was “currently defining common criteria of core Tier 1 capital”, which will be applied consistently across EU banks.
The definition of core Tier 1 capital differs across Europe and national banking regulators have yet to agree what assets can count under this measure.
The stress tests, which will be published in June, are designed to assess the resilience of European banks to hypothetical external shocks, identifying vulnerable financial institutions and recommending a strengthening of capital levels where this is needed.
“This time around it will be the adverse macroeconomic scenario that will drive capital requirements,” Davy Research banking analyst Emer Lang wrote in a note to investors.
“Translating it into stress level bank impairment losses remains the key challenge,” she said.
The hypothetical adverse scenario examines the possible trading losses of banks were there to be a “sovereign shock” or a fall in the price of EU sovereign bonds.
Banks will be expected to disclose their exposure to sovereign debt, broken down by country and maturity. However, the EBA stress tests will not directly test for a theoretical sovereign default.
The EBA is co-ordinating the stress tests in conjunction with national financial regulators, the European Systemic Risk Board, the European Central Bank and the European Commission.
Last year’s stress tests were regarded as a flop, after only seven banks failed. All of Ireland’s banks passed, despite subsequently needing external financial assistance.
The Irish Central Bank is due to publish the results of its own stress tests on March 31st.
On Wednesday, the Central Bank said the macroeconomic scenarios it was using in its tests were consistent with the EBA’s approach. – (Additional reporting: Reuters)
IRISH SENIOR DEBT MAY BE 'SMART TRADE': SOCIETE GENERALE'S NOTE TO INVESTORS
INVESTING IN Irish senior debt “could be a smart trade” for “very risk-tolerant investors”, banking analysts at Société Générale have written in a note to investors.
However, the chance that the Government may coerce bondholders into a burden-sharing arrangement means risk-averse investors should avoid all Irish debt, SocGen said in a research note.
The French bank said its sales and trading desks had received “numerous enquiries” from investors who have “begun to dip their toes” into medium-term Irish senior debt.
This suggests that an increasing number of investors believe it is unlikely that the Government will take action against senior bondholders in order to reduce the cost to taxpayers of bailing out the banking system.
But the bank’s analysts caution that a “bail-in” remains “a wild-card that the Irish Government may play over the short term in negotiations” with the European Union, “despite toned-down rhetoric as the recent election campaign progressed”.
SocGen analysts Hank Calenti, Jean-Luc Lepreux and Stéphane Le Priol write that a “bail-in” of some €13.5 billion of senior unsecured debt and subordinated debt at Irish banks that have directly received State aid would generate potential “savings” to the Government of €9.4 billion.
“This represents much more than the Irish Government can save by negotiating a 1 percentage point decrease of the interest rate on the EU bailout funds,” they note.
The risk to investors of systemic action by the Government “remains too large relative to the long-term upside potential that these securities may offer for most investors”, it concludes.
The note adds that “Bank of Ireland continues to look like the last large Irish bank standing” and that they may become less concerned about investing in this bank once the Government’s renegotiation of the repayment terms on the EU-IMF deal is complete.
