Stringent new round of stress tests planned for banks

EU FINANCE ministers have resolved to conduct a new round of more stringent stress tests on Europe’s banks, a decision that reflects lingering dissatisfaction with the first pan-European examination of the sector only five months ago.

After the failure of the first test to take account of liquidity pressures, economics commissioner Olli Rehn said the new stress tests would be based on new financial architecture. “We need to opt for fullest possible transparency when conducting the bank stress test,” he told reporters in Brussels.

“One of the lessons learned is that we will have to have a liquidity assessment in these stress tests next time around.” The new tests will be “even more rigorous and even more comprehensive”, the commissioner added.

Allied Irish Banks and Bank of Ireland each passed the examination last July, but both now require new capital as part of the €85 billion rescue plan agreed with the EU and IMF.

EU leaders had hoped the first test would reassure investors by uncovering hidden problems and forcing weaker lenders to recapitalise. However, the low failure rate in the first test and the fact that problems in the two largest Irish banks went uncovered led critics in financial markets to question the merits of the exercise.

While only seven out of 91 European banks failed the previous health check, the decision to press ahead with the new test represents a renewed effort to boost confidence in the sector and identify any new problems before they become irreversible.

European Central Bank (ECB) officials have privately acknowledged the failure of the EU-wide stress tests on 91 European lenders to determine whether banks are facing funding crises.

ECB officials have pointed to the difficulties in applying a single stress test across EU banks – particularly lenders with cross-border operations – and publishing results without sparking a potential run on deposits and immediate fear among investors.

The previous tests assessed the loan losses banks faced, but did not examine potential pressures on funding and deposits on the other side of bank balance sheets.

Despite passing the prior test, AIB and Bank of Ireland must now raise an additional €5.3 billion and €2.2 billion respectively to bring their capital levels up to new international standards to reassure the financial markets of their viability.

The nationalised Anglo Irish Bank was not tested last July, as the bank is to be wound down.

The three Irish banks have lost total deposits of €35 billion since the start of the year over fears about the scale of Ireland’s financial problems. This forced them to draw heavily on emergency funding from the ECB, to the extent that their reliance on the bank was out of all proportion to Ireland’s size. This was one of the prime factors in the instability that ultimately led the Government to seek external aid.