BRUSSELS — Regulators in Europe have revealed which of the 150 of the European Union’s biggest banks have proved they are strong enough to weather another financial crisis.
The supervisors have been checking how valuable the assets are on banks’ balance sheets, how much of that value those assets – ranging from mortgages, to bond investments and corporate loans—would lose amid simulated financial and economic shocks, and whether lenders have enough capital to absorb those losses.
What’s the point of stress tests?
The EU’s economy has been struggling ever since the financial crisis first took hold in 2008. EU officials and economists say that this is partly due to banks’ reluctance to lend to households, companies and each other, holding back much-needed investment. They hope that the stress tests will weed out weak banks and demonstrate to investors that the bloc’s financial system is safe.
Who’s running them?
The European Central Bank scrutinized 130 banks in the 18 eurozone countries and Lithuania, which is set to join the currency union on Jan. 1. National regulators have helped it carry out the tests. The London-based European Banking Authority is has overseen the stress tests for 123 banks across the 28 European Union countries, some of which, including the U.K., aren’t in the eurozone. The majority of banks are in both samples and the scenarios are the same for both exercises. The asset quality review, which first checked the value of assets used in the exercise, was carried out by the ECB and national supervisors.
Why are they happening now?
After severe banking crises in Ireland, Spain and Cyprus, the 18 EU countries that use the euro decided last year to put the ECB in charge of supervising their big banks. National supervisors, officials argued, had too often failed to spot problems in their banking sectors, either because they were scared of the fallout or unable to understand cross-border risks. The ECB wanted to run the stress tests before it takes over on Nov. 4 to be sure old problems are taken care of.
Tell us more about that test on the value of assets
In contrast to previous stress tests, this year’s exercise was preceded by the asset-quality review. In this review, supervisors checked whether banks overstated the value of their assets. The actual stress tests, where banks have to weather a simulated three-year shock, only happened after that. One thing to pay attention to is that the ECB is also testing around 30 eurozone banks that aren’t taking part in the main stress tests run by the European Banking Authority, which covers all 28 EU countries.
What are the hurdles that banks have to pass?
Banks had to demonstrate that their core capital buffers wouldn’t fall below 8% of risk-weighted assets after the asset-quality review and if the economy develops as expected until 2016. Under the crisis scenario, which sees the EU slip into a two-year recession and experience the kind of market panic seen after the collapse of U.S. investment bank Lehman Brothers, banks have to maintain a capital buffer of at least 5.5%.
What happens if a bank fails?
Banks that fail the stress tests have to increase their capital buffers. They can do so either by selling new shares or divesting assets. Lenders that can’t find capital from private sources may need help from their governments. However, before any taxpayer money is injected into a bank, its shareholders and subordinated creditors have to take losses.
What happens next?
Problematic banks have two weeks to come up with plans for how to raise new capital. Lenders that fail the asset-quality review or the test’s baseline scenario have six months to put these plans unto action. Banks that fail only in the crisis scenario are given nine months. In severe cases, for instance if a capital hole is discovered at a very big bank, supervisors may have to announce measures as soon as Sunday afternoon.
