One bad loan definition for stress tests sought

Banks across the EU will be asked to use a single definition for bad loans in the upcoming review of their loan books, a senior EU regulatory source told Reuters, making it harder for banks to conceal the state of their businesses behind local conventions.

The ECB hopes to begin work on an asset quality review of major banks in the 17 eurozone countries later this year. The review will take a detailed look at whether they’ve set aside enough cash to deal with debts unlikely to be repaid, so the ECB can stand over the state of the banks’ before it becomes their official supervisor in late 2014.

National supervisors elsewhere in the EU will conduct a similar review for the non-eurozone states.

Both reviews, which will be co-ordinated by pan-EU regulator the European Banking Authority, will focus on ‘problem categories’ of loans in individual countries, looking at areas like shipping, commercial real estate and mortgages in some markets.

A senior EBA source told Reuters a key feature of the asset quality review will be harmonising the way banks categorise loans. EU supervisors use a host of different ways to classify troubled or non performing loans, making it difficult to compare across jurisdictions.

The EBA recently carried out a consultation on a single definition to be used across the EU and is working on firming up that definition by September.

In a note published on Wednesday, Moody’s Analytics said harmonised NPL definitions would “set the foundations for a new European standard for stress testing”.

“These standards will also give the ECB’s supervisory role much greater credibility when the banking sector and investors need it most,” the note from Moody’s Analytics managing director Alessio Balduini added.

The 2011 version of the stress tests, which relied entirely on national supervisors’ submissions, was widely criticised for finding that Europe’s 70 largest banks collectively needed just €106bn. The EBA is keen to ensure this round of stress tests has more credibility.