Stress tests show EU banks have capital shortfall

Fri, Dec 9, 2011, 00:00

BANKS IN the European Union must hold onto more profits, lower bonuses to staff and sell assets to ensure that they have enough of a buffer to deal with a full-blown European Union sovereign debt crisis, the European Banking Authority has warned.

In a document issued in London last night, the authority said European banks needed €114.7 billion more in capital to protect themselves from future shocks, while a number of German banks alone needed to find an extra €13 billion.

None of Ireland’s banks was included in the list produced by the authority last night because they have already been recapitalised under the EU-International Monetary Fund package for Ireland agreed last year.

In a bid to ensure that it is not accused of provoking renewed sell-offs of sovereign debt from EU states, the authority emphasised last night that its figures were based on end-September dates: “The sale of sovereign bonds will not alleviate the requirements needed,” it said.

Despite telling banks to build a new buffer, the authority, which supervises the EU’s banks, has told them they must not reduce lending to business and personal customers, and warned that such deleveraging will not be included in its figures.

Banks must produce plans to the authority by January and have the increased core tier one buffer in place by June, with the authority accepting that banks could not reasonably be expected to raise the money before then given the unsettled nature of the capital markets.

“These buffers are explicitly not designed to cover losses in sovereigns but to provide a reassurance to markets about the banks’ ability to withstand a range of shock and still maintain adequate capital,” the authority said last night.

However, it emphasised that the buffer was a “temporary measure” and would be reviewed once the European Financial Stability Fund was deployed to lift “sovereign bond valuations from today’s distressed prices”.

Previously, the authority had estimated that EU banks would need to raise €106 billion, but the extra €8 billion included in last night’s figures is due to the sharp falls in values suffered by much of the government bond holdings kept by banks.

Before publication of the findings, some analysts believed that the capital shortages would have fallen from €106 billion, not increased, since banks have worked to retain profits, convert debt to equity and sell off loan portfolios. The implications are most serious in Germany, where Commerzbank, the country’s second biggest privately owned bank, is now facing nationalisation after the authority decided that it must raise €5.3 billion, not €2.9 billion.

However, the supervisors’ verdict has provoked fury: “The stress test hasn’t contributed to market stabilisation,” Michael Kemmer, general manager of the BDB association of German banks, told Bloomberg, adding that the process had been “arbitrary, lengthy and seemingly chaotic”.

Commerzbank shares plunged 11 per cent in late trading.