The European Banking Authority said it is asking banks to use a stricter standard for assets they keep in case of unexpected losses. It’s now requiring them to use the tougher Core 1 measure, which excludes some kinds of assets. That’s tougher than the plain Tier 1 standard used in last year’s tests, which were regarded as not tough enough to be credible.
The tighter definition is aimed at making sure banks have the resources to get through unexpected losses, shoring up confidence that banks could withstand a worsening of Europe’s financial troubles or another economic downturn.
Some banks, notably in Ireland, which passed last year’s tests ended up requiring government help to survive as their debt obligations swelled.
The current debt crisis among European governments is often viewed in part as a potential banking crisis, since government bonds are widely held by banks and market losses, or a default, would hit their finances.
So far, Greece and Ireland have had to be bailed out to avoid defaulting on bonds, and Portugal has turned to the European Union for a bailout too after its shaky finances led bond markets to judge it as too risky to loan money at affordable rates. Additionally, collapsed real estate markets in several countries have caused bank losses on real estate loans that in turn hit governments in the form of bailout costs.
The high cost of Ireland’s banking cleanup is largely what drove its government to the brink of bankruptcy.
The core Tier 1 standard adopted for the test excludes preference shares and some kinds of silent participations, a kind of non-voting holding that can be counted as core capital in Germany.
Banks would have to stay over a five percent core Tier 1 capital ratio, measured against their assets such as loans and bonds, adjusted for riskiness.
Banks will also be subjected to a scenario in which Europe’s economy shrinks 0.4 percent this year and does not grow at all next year — four percent below current estimates. Last year’s test included a three percent drop below expectations.
The list of 90 banks that make up 65 percent of the European banking system includes all banks that were in last year’s test except for those that no longer exist independently. Banks that were added are Austria’s Oesterreichische Volksbank AG, Denmark’s Nykredit, Ireland’s Irish Life and Permanent, Norway’s DnB NOR Bank ASA, and Slovenia’s Nova Kreditna Bank Maribor D.D.
