EU banks to estimate capital needs in event of new slump

EUROPE’S banks have been asked to estimate how much additional capital they would need under two adverse scenarios as part of stress tests aimed at reviving confidence among investors.

Europe is testing how 91 banks, including Bank of Ireland and AIB, would cope with another economic slump and losses on government debt after the Greek crisis hit markets and raised fears the euro-zone could unravel.

With few details available about the terms of the test and early divisions among the 27 European Union members over how much information to divulge, investors have worried the assessments would not be tough or transparent enough. According to a document sent to banks and obtained by Reuters, banks must estimate how much more capital they might need to achieve a tier 1 capital ratio of 6% under three different scenarios.

They have been asked to estimate their tier 1 capital ratio at the end of 2011 under a base scenario, an adverse scenario including two years of economic deterioration, and an adverse scenario with an “additional sovereign shock”.

Capital is held by banks to protect deposits, and tier 1 is a standard measure that includes common stock and retained earnings. Sources said the template letter was sent to all the banks participating in the test, which is being coordinated by the Committee of European Banking Supervisors (CEBS).

The details were released as top bankers met the European Central Bank in Frankfurt.

Major listed banks, which face constant investor scrutiny, are expected to pass, but the tests may show the worst problems lie with smaller players such as Spanish cajas and German landesbanks, which are mainly unlisted.

Arturo de Frias, analyst at Evolution Securities, named National Bank of Greece and Banco Popular as some of those at risk of failing the test.

“We expect perhaps a few of the cajas failing and a few of the landesbanken failing, but no large bank having to ask for more capital,” de Frias told Reuters Insider.

“The question is whether the smaller domestic players, like in Greece and Spain, will fail.”

German nationalised lender Hypo Real Estate will likely fail the test, but officials and bankers from several countries including Germany, France, Greece and Belgium have said their banks should pass, raising concerns the assessment is too lenient to reassure the markets.

Under the harshest scenario, banks are asked to include cumulative losses for this year and 2011 for “additional losses on sovereign exposures in the trading book” and impairment losses on the banking book, where assets are held to maturity and not regularly marked to market prices.