The European Central Bank says it will look for capital shortfalls in euro-area banks by examining more than €3.72tn in assets in on-site checks.
Releasing a 285-page manual for staff undertaking the asset quality review, the Frankfurt-based ECB said any adjustments to lenders’ capital ratios identified as necessary by the unprecedented balance-sheet probe will be determined during July.
While banks won’t have to revise their 2013 accounts, they may have to raise extra capital once the results are published in October following a stress test.
Staff from the ECB, national supervisors and auditing firms will, in the coming months, divide the health check into 10 work areas to examine assets from shipping loans to commercial real estate, comprising about 160,000 individual credit files.
The review, which covers 58% of the risk- weighted assets held by the 128 banks in the exercise, is part of the ECB’s preparations to take over supervision of the region’s biggest lenders in November, in the first pillar of a nascent banking union.
“Banks will be expected to reflect findings from the asset quality review, in their accounts, where found necessary in the relevant accounting period in 2014 following the asset quality review,” the ECB said in a statement.
Findings related to unrealised losses, along with the stress test, “will form the basis for supervisory measures requiring banks to cover potential capital shortfalls,” it said.
The ECB said banks would only be expected to restate 2013 results if local laws on reporting appeared to have been contravened, an event deemed “unlikely.”
The asset quality review is the second stage in the ECB’s comprehensive assessment. The first phase identified which bank assets should be studied, and the third and final stage will be the stress test to see if lenders can survive an economic or financial downturn.
The on-site asset quality review work began in mid- February with a review of banks’ policies for processing and accounting for their business, the creation of a database of individual loans to be examined, and a cross check of the quality of the data.
The ECB hasn’t commented on the number of people required for the work or the costs to the lenders involved.
The work will be followed this month by a process to check whether loans have been correctly classified by banks, and if the appropriate provisions against potential losses have been made.
“The credit file review work block will also be used to identify cases where a loss-event trigger has not been hit, but a loss is more likely than not,” according to the ECB manual.
“For these cases the expected future loss will be measured for consideration in the stress test.”
A valuation of collateral and real-estate assets will follow from mid-March to June, roughly parallel with an examination of harder- to-value assets such as derivatives.
The use of the asset review as an input for the stress test is the main reason the ECB’s current review is more credible than previous attempts to determine the health of the region’s banking system, ECB vice president Vitor Constancio said last month.
Banks will have to show they can maintain a capital ratio of 8% of risk-weighted assets for the asset quality review.
For the stress test, the full details of which have not yet been released, a threshold of 5.5% of risk- weighted assets will be applied.
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