Europe's banks have been asked to estimate how much additional capital they would need under two adverse scenarios as part of stress tests aimed at reviving confidence among investors.
The stress test process will be a hot topic when some 40 top bankers, including the heads of Deutsche Bank and UniCredit, meet European Central Bank president Jean-Claude Trichet in Frankfurt later today, people familiar with the situation said.
Europe is testing 91 banks on how they would cope with another economic downturn and losses on some government debt, in an effort to restore confidence after the Greek crisis hit markets and sparked fears the eurozone could unravel.
With few details available about the terms of the test and early divisions among the 27 members of the European Union over how much to divulge, markets had begun to worry that the assessments would not be tough or transparent enough.
According to a document sent to banks, the institutionsmust estimate how much more capital they might need to achieve a Tier 1 capital ratio of 6 per cent under the scenarios.
They have been asked to estimate their Tier 1 capital ratio at the end of 2011 under a base scenario, an adverse scenario including two years of economic deterioration, and an adverse scenario with an "additional sovereign shock".
Sources said the template letter was sent to all the banks participating in the test, which is being coordinated by the Committee of European Banking Supervisors (CEBS). The results of the test will be published on Friday.
Bankers and officials from countries including Germany, France, Greece, and Belgium have said their lenders will pass the tests, raising concerns they are too lenient.
Markets had also been left wondering whether the test would be based on Tier 1 capital or core Tier 1 capital, which excludes some types of capital.
National regulators can vary on what qualifies as standard capital, and there has been concern among some investors that the test may not be evenly applied across all 20 countries.
The document seen by Reuters asks banks to estimate their total Tier 1 capital and their Tier 1 capital ratio at the end of 2011 under each scenario.
Under the harshest scenario, banks are asked to include cumulative losses for this year and 2011 for "additional losses on sovereign exposures in the trading book" and impairment losses on the banking book.
Major listed banks are expected to pass, but the test results are expected to show the biggest problems lie with smaller players such as Spanish cajas and German landesbanks, which are mainly unlisted.
German nationalised lender Hypo Real Estate will likely fail the stress test, but officials from several countries have said their banks should pass.
Under the harshest scenario, banks are asked to include cumulative losses for this year and 2011 for "additional losses on sovereign exposures in the trading book" and impairment losses on the banking book.
One banker familiar with the test said the "haircuts" on the value of sovereign debt held in the trading books would range from 3 per cent up to 22 per cent from market prices. The impairment losses include bad loans from soured corporate and retail loans, based on economic deteriorations that vary between countries.
Germany Chancellor Angela Merkel said the conditions for the stress tests were "very realistic".
Chief executives from Austria's Erste Group and Nordic lender Nordea joined the chorus of upbeat comments and said their banks will pass the test.
Reuters