ECB vice president Vitor Constancio said the fact that eurozone bank balance sheets will be probed before undergoing a simulated economic downturn later this year makes the test harder to pass.
“We have our own big add-on, in that we will integrate the results of the asset-quality review into the stress test, which will aggravate the results of the stress test,” Constancio said in Frankfurt yesterday after giving an update on the ECB’s health check of the financial system.
The ECB said the region’s largest banks will have to show their capital won’t fall below 5.5% of their risk- weighted assets in a crisis, matching stress-test parameters set by the European Banking Authority.
The ECB is conducting its year-long assessment of lenders before taking over supervision duties for the eurozone in November, in the first pillar of a banking union intended to prevent a repeat of the financial meltdown that almost splintered the currency bloc. ECB president Mario Draghi has said the assessment is key to bringing confidence back to the banking system and fostering the recovery.
Constancio argued that the 5.5% ratio is tougher than previous exercises, as it must be made up of the highest-quality form of capital, known as common equity Tier 1.
“We are talking about a common-equity threshold, it’s not Tier 1, which by itself is more demanding than any previous thing,” he said. “The strictness of the stress test can’t be measured by the threshold. It depends on the whole exercise, the extent of the shocks and so on. We can’t draw conclusions just from the threshold.”
The scenarios to be used in the stress test will be developed in coming months, and will be communicated to the banks by the end of April, Constancio said. Previous stress tests run by the EBA, which required a 5% capital ratio, foresaw a drop in output, a rise in unemployment and a fall in asset prices, and then mapped the effect against banks’ assets.
The ECB also outlined the definitions for non-performing loans in the second part of the assessment, known as the Asset Quality Review. The review is the second stage in the ECB’s Comprehensive Assessment, a review of bank balance sheets to identify any capital shortfalls. The first phase identified which assets from government debt to mortgages and shipping loans should be studied, and the third and final stage will be a stress test to see if lenders can survive a downturn. The results will be published before oversight formally starts.
The chair of the ECB’s new supervisory board, Daniele Nouy, said the review is on schedule and that the central bank will conclude the portfolio selection stage by the middle of this month.
The ECB will also review Level 3 assets, which are the most-difficult to value assets for which banks have to assign their own models because they aren’t liquid, Nouy said.
“This will only be for banks with material Level 3 exposures,” he said. “This is where the risk is the biggest, where the prices are not coming directly from the market.”
Bank holdings of sovereign debt, and their respective maturities, will also be disclosed in full.