Stringent ECB stress tests will turn spotlight on strength of Irish banks

Going by the details provided by the ECB, the forthcoming asset quality review and stress test of the banking system is intrusive enough to restore confidence among investors.

The successful and credible completion of this exercise is crucial if the eurozone is to return to some sort of normality.

The European Banking Authority presided over region-wide stress tests in 2010 that passed all the Irish banks, even though they were subsequently nationalised.

There will inevitably be bank failures and capital raises along the way on this occasion. The obvious concern for the Government is how the three domestic banks, Bank of Ireland, AIB and Permanent TSB, perform during the tests.

The State has only a 14% share in Bank of Ireland. According to chief executive, Richie Boucher, the bank is now making a profit and adding to its capital levels. It is already well capitalised so it is well positioned to pass the asset quality review and the stress tests. Moreover, in the event it does need more capital, then it would be up to its shareholders to stump up the cash.

AIB and PTSB are 99.8% and 99.2% state-owned respectively. The stakes are much higher. In the case of PTSB, it has a restructuring plan before the European Commission. The proposal is to split it into a good bank; an asset management unit to wind down its troubled assets; and a separate UK division that will be sold this year.

However, the prospects of the restructuring plan getting approval hinge on securing a funding line for the asset management unit. If this is not forthcoming before the stress tests, then it could present problems for the bank. PTSB has very high capital buffers, but the stress tests will take a forward looking view of the bank’s viability.

AIB is scheduled to return to a post-provision profit this year. It has high levels of non-performing loans, although it also has high levels of capital buffers and coverage ratios.

But if either bank fails the stress tests, then recapitalisation will become the responsibility of the Government.

Speaking to reporters in Brussels yesterday, Finance Minister Michael Noonan said he was confident that the Irish banks would pull through the stress tests.

“Ireland has been over that ground twice with first a full stress test and second asset quality review before Christmas.

“In the rule book it’s very similar to our first stress test. Two scenarios, is if things continue as they are now, and under stress conditions they make assumptions about how the files in the bank would perform if property prices drop by 20% which was the assumption in last Irish test.”

“It’s the view of the banks themselves and the Central Bank that no extra capital will be required.

“We did it three years ago and put a lot of capital in and the situation has improved rather than deteriorated,” added the minister.