Europe’s banks brace for clutch of health test failures

LONDON: A health check of European banks is expected to show that as many as 15 lenders need more capital to withstand a prolonged recession, with criticism growing that the tests do not encompass the impact of a Greek default.

Europe's bank “stress test” (to be published at 1600 GMT after StarBizWeek press time) would make 90 lenders reveal for the first time their profit forecasts, a breakdown of their sovereign bond holdings and funding costs, and will force the weakest to recapitalise.

The International Monetary Fund has warned Europe it was taking too long to rebuild its banking system and had lagged repair work done in the United States since the financial crisis, while the threat of the Greek debt crisis spreading to bigger countries such as Spain and Italy had rattled investors and dragged European bank shares to a two-year low.

“Markets are likely to be dominated by views on the sustainability of sovereign debt. As long as there is no definitive answer to this, there is not much space for a stable recovery in the bank space,” said Carlo Mareels at RBC Capital Markets, who expects a total capital shortfall of 30 billion to 35 billion euros, a fraction of the 110 billion euros expected to be needed for a second bailout of Greece.

Eurozone sources told Reuters two weeks ago that 10 to 15 banks were likely to fail the test, with casualties expected in Spain, Greece, Germany and Portugal although no large bank was expected to fail.

Critics say the health check fails to reflect market expectations that Greece will default on its debt in some form, which would pile up losses for German and French banks that hold large amounts of the country's debt.

The European Banking Authority is not forcing banks to explicitly haircut sovereign bonds held in their long-term banking book, but has told banks to include the estimated hit of potential losses from holdings based on a theoretical four notch credit rating downgrade, which would mean a low rate country like Greece had defaulted.

Under the test, banks would take a 15% “haircut” on Greek bond holdings, while most market experts expect to see up to half the value of those bonds wiped out at some point. - Reuters