Banks face ‘toughest’ stress tests yet

European Union officials are preparing to pit the bloc’s banks against the toughest simulated recession that they have ever faced in a stress test, three people briefed on the matter said.

Sat, 26 Apr, 2014 - 01:00

Jeff Black, Ben Moshinsky and Alessandro Speciale

The European Banking Authority (EBA) and the European Central Bank (ECB) will next week unveil an adverse scenario for the stress tests, which start in May, that assumes the 28-nation bloc’s economy undershoots EU growth forecasts by a greater margin than in the exams held in 2010 and 2011, said the people, who declined to be named as the details aren’t yet public. Those previous tests were criticised for failing to uncover weaknesses at banks that later failed.

This time around, the stress test’s adverse scenario is predicated on economic output that misses the European Commission’s growth forecasts by 2.2 percentage points in 2014, 3.4 points in 2015 and 1.4 points in 2016, the people said, citing an EBA document.

That probably translates into two years of recession followed by anaemic growth in the last year covered by the exercise. The EBA plans to announce the details in London on April 29. A spokesman for the EBA and a spokeswoman for the ECB declined to comment.

The ECB is running an assessment of 128 banks as it prepares to assume full oversight of euro-area lenders in November. The exam, which applies to banks in the entire EU, requires banks to maintain a capital pass mark of 5.5% of risk-weighted assets.

The ECB has said the baseline for the scenario will be formed around the commission’s spring economic forecasts, which are due to be published in May and provide an outlook for 2016 for the first time. The commission’s winter forecasts assume EU growth of 1.5% this year and 2% in 2015.

The current scenario foresees unemployment rising in each of the three years, overshooting the baseline forecast by 0.6 percentage points in 2014, 1.3 points in 2015 and one point in 2016.

That would simulate EU-wide unemployment exceeding its highest-ever annual average level of 10.8% last year.

Bloomberg