Banks can stand a bigger slowdown, finds EU stress test

A stress test of the European Union’s biggest banks showed they could withstand an even deeper recession, though with almost 400 billion euros ($581 billion) in losses, according to a report to EU finance chiefs.

Under current EU economic forecasts for 2009 and 2010, the largest banks in the region would maintain an average Tier-I capital ratio “well above” 9 per cent, the officials said yesterday in a statement after meeting in Gothenburg, Sweden. A “more adverse” scenario would boost losses and cut the average ratio to about 8 per cent.

The five-month study was ordered by ministers after a similar one in the US European Central Bank President Jean-Claude Trichet emphasised that the potential losses for the region’s 22 largest banks represents an “adverse” scenario and not a base-line case.

“All systemic institutions showed that they were very resilient,” Spanish Economy Minister Elena Salgado told reporters today. “That’s a good result.”

No bank among the 22 included in the test would see its Tier-I capital ratio fall below 6 per cent as a result of the adverse scenario, according to the statement. The minimum Tier-I capital requirement for banks under the Basel accords is 4 per cent.

Earnings forecasts
“This resilience of the banking system reflects the recent increase in earnings forecasts and, to a large extent, the important support currently provided by the public sector to the banking institutions,” the officials said, referring to capital injections and asset guarantees.

European financial institutions have posted $498 billion in losses since the onset of the credit crunch in mid-2007, less than half the $1.08 trillion in losses reported in the US, according to Bloomberg data.

US regulators found earlier this year that 10 financial companies led by Bank of America Corp needed to raise a total of $74.6 billion of capital, in results made public on May 8. Releasing the findings helped calm investors, US Comptroller of the Currency John Dugan, who oversees national banks, said at the time. The EU didn’t publish the names of the banks it studied.

Trichet and other officials said the methodology used in the report, prepared by the Committee of European Banking Supervisors, differed from that used by the US authorities and the International Monetary Fund (IMF). The divergence in part reflects different accounting standards, they said. The Washington-based IMF this week cut its projection for global writedowns on loans and investments by 15 per cent to $3.4 trillion, citing improvements in credit markets and initial signs of economic growth.