New stress tests require bank capital ratio of 5.5%

European Union banks face their toughest probe yet in a bid to weed out the sector’s weaklings, the bloc’s chief watchdog said yesterday, announcing stress tests intended to help draw a line under the financial crisis.

More than half a decade since the start of the 2008-09 credit crunch, and despite more than €1 trillion of state support, confidence in the sector remains fragile and the EU’s latest health checks are intended to settle any lingering doubts over its finances.

The European Banking Authority (EBA), the EU watchdog coordinating the tests, said yesterday that to pass, banks must have a core capital ratio of above 5.5% during the three-year stressed scenario, including above 8% at the starting point.

This reflects the amount of capital reserves banks have to put aside to cover unpaid loans or market bets that go wrong and represents a higher bar than in previous tests or before the crisis, when it was typically about 2%.

For the banking sector as a whole a key issue is whether the tests will force another round of multi-billion euro capital-raising via share issues, but the answer to that question won’t emerge until later in the process.

Some banks, such as Deutsche Bank and Monte dei Paschi have moved early to bolster their balance sheets but there may be more to come. The Bank of Italy, for instance, has said some smaller Italian lenders may need €1.2bn in total.

Analysts have estimated the tests could show a total shortfall of up to €100bn.

The 2014 tests will apply to 124 banks across the EU, such as leading lenders BNP Paribas, accounting for roughly €30tn in assets. The stresses being tested will be revealed in April or May.

“The more rigorous the better,” said Francisco Gonzalez, chairman of Spanish bank BBVA. Angel Ron, chairman of rival Banco Popular, said the 5.5% threshold is demanding but his bank is “very well prepared”.

The EBA is mapping out a timeline and common methodology that must be applied to all banks, but some national supervisors will add additional risks to be tested. Germany, for example, is likely to also test for exposure to the shipping business, to which some of its banks lent heavily.

The Bank of England said its own stress test of eight banks, including Barclays, HSBC and RBS, will run alongside the common EU test, dashing lenders’ hopes it would be a substitute.