Fears of eurozone deflation, emerging markets turmoil and a determination not to repeat past mistakes mean European regulators are likely to come up with the toughest set of tests for the region’s banks that they have ever faced.
The European Banking Authority (EBA) is tomorrow to reveal the crisis scenarios that banks will have to prove they can withstand without resorting to the kind of taxpayer bailouts that all but bankrupted some countries in the 2008 to 2012 crisis.
Banks that fall short of capital under the imagined scenarios will have to produce a plan to boost their reserves by raising fresh funds from investors, selling assets or hanging on to profits instead of paying dividends.
Banks have already raised billions in capital and made other reforms ahead of the tests, which regulators hope will finally banish any investor doubts about the industry and allow it to refocus on lending to boost growth.
The European economy has rallied since the last round of bank stress tests three years ago and sharply lower borrowing rates for countries such as Greece — which can now borrow five-year money at an interest rate below 5 percent against the 20 percent it was paying when the 2011 tests were done — support the idea that the worst of the eurozone crisis has passed.
However, with widespread criticism heaped on 2010 and 2011 stress tests for being too soft, and new risks on the horizon, regulators are likely to set tougher conditions all the same.
Figures leaked ahead of tomorrow’s announcement show regulators are taking a tougher line on economic growth than in 2011, when 18 of the EU’s 27 countries at that time posted weaker growth than the “adverse” case they were tested against for 2012.
The most dramatic miss was Greece, where an adverse scenario of a 1.2 percent contraction in real GDP proved far more optimistic than the 7 percent contraction that actually occurred.
The last version of the US stress tests set the adverse scenario for domestic GDP at as much as 4.7 percentage points worse than the expected scenario for one quarter, though the average gap was closer to 2 percentage points.
The EU tests have a gap of between 1.5 percentage points and 2.2 percentage points between the base and the adverse cases.
Analysts view economic growth as the most significant factor in the stress tests, with KPMG’s Smith noting that losses on banks’ mortgages and business loans would be primarily driven by GDP projections, as well as assumptions around unemployment.
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