BRUSSELS, March 18, (Agencies): The European Union bank regulator said Friday that this year’s stress tests on banks will be harsher than last year’s, which were widely considered a failure, though important elements of the exercise deemed crucial to the region’s crisis strategy remained undecided.
The test will see how banks fare with an extreme deterioration in financial markets and economic activity in order to gauge where the weak links in Europe’s financial system are. Last year’s tests were discredited after some banks passed, only to require bailouts weeks later.
The new simulation will assume EU economic output will shrink 0.4 percent in 2011 and will show no growth in 2012 — a 4 percentage point difference from current forecasts, the European Banking Authority said. That compares with a 3 percentage point drop assumed in the 2010 stress tests.

However, even though the tests’ results are due to be published in June, some important elements are still up in the air.
Crucially, the bar that banks would have to jump to pass the tests — namely the minimum capital ratio they have to maintain despite the shocks — was still missing from the scenarios published Friday. The so-called core Tier-1 capital ratio currently varies from country to country and the EBA said it was still in the process of defining the one to be used for the tests.
It also wasn’t clear how many banks would be tested this year. The EBA only said that the tests would cover a “broadly similar group of banks” as last year, when 91 banks were included, and that the banks would represent more than 65 percent of EU banking assets. In recently leaked documents the EBA said 88 banks would be tested but the number was not included in Friday’s release.

The EBA faces the challenge of asserting its credibility against 27 national banking supervisors, many of whom are eager to protect the banks under their own watch. The discovery of huge capital holes in one country’s banking system could not only become expensive to the national government but also make those banks vulnerable to takeovers.
The EBA has come under fire for not setting stricter shock scenarios for banks, with critics saying a partial default of a highly indebted country like Greece cannot be ruled out. However, banks will have to disclose all relevant exposure to sovereign bonds — including those of non-EU countries like the US and Japan — which would allow analysts to run their own calculations.

The bank stress tests are seen as a central part of Europe’s efforts to find its way out of a debt crisis that has already forced Greece and Ireland into international bailouts. Huge problems in Irish banks were the main reason that Ireland had to seek international help.
Analysts are also concerned about the health of banks in stronger countries like Germany and France, which are very exposed to Europe’s troubled economies.
EU stress tests conducted last year were widely seen as a whitewash when only seven of 91 tested banks failed, and two Irish banks that passed the tests had to be rescued soon after.
Europe is attempting to raise the bar on capital just as US banks expect to be told they could be allowed to return cash to investors after a second round of stress tests there.
“It is likely to result in a demand for more capital (from) European banks just as the Fed is telling US banks that some of them are in a position to return capital,” said Jon Peace, analyst at Nomura in London. “We have definitely got the US and Europe moving in opposite directions at the moment.”
Stress testing of about 90 European Union banks began this month, and on Friday the European Banking Authority published details of the economic shock that will be applied to individual banks and the test’s methodology.

Last year banks had to meet a so-called Tier 1 capital requirement of 6 percent to pass.
This refers to a broad measure of a bank’s resilience, but lenders can pad it with lower quality assets which obscure how much cash is available to tap.
Analysts would have preferred a stricter ‘core’ Tier 1 benchmark comprising shareholders’ capital and retained earnings, possibly with a 5 percent pass rate.
The US Federal Reserve, which conducted the second wave of tests on US lenders, will allow banks including JPMorgan to lift their dividends after the tests, the Wall Street Journal reported.
Analysts said that could lift US bank shares while the threat of capital raising could weigh on European rivals, potentially widening the premium the US sector trades at.
By 0850 GMT the DJ Stoxx European bank index was down 0.2 percent, underperforming a 0.5 percent rise in the broader European share market.

EBA officials say investors should have more confidence in this year’s test because of what they say is a tougher economic shock and a better review of data to ensure consistency.
The EBA did not list the banks to be tested, saying it had not been finalised. The sample will represent 60 to 65 percent of EU banking assets, and results will come in late June.
Regulators hope there will be enough detailed information published on individual banks for analysts to run their own tests.
The EBA expects finance ministries will have plans in place before the results come out to show how failed banks on their patch would be recapitalised.
The authority ultimately hopes the results in June will be convincing enough to break the perceived link between banking problems and the wider concerns over high levels of government debt in some euro zone countries.