Publishing guidelines on Tuesday for its forthcoming asset quality
review (AQR), the ECB said it would trawl through trillions of euros
of assets at 128 leading banks between now and August, aiming to
ferret out any problems before it takes over as the euro zone's
banking watchdog in November.
The exercise is part of a bigger plan to harmonize the way banks are
supervised and if necessary wound down, aiming to restore the
sector's stability and avert a repeat of the debt crisis which cost
trillions in taxpayer bailouts.
While preparations for coordinated supervision are already in full
swing, European ministers were still trying to agree on how to build
a safety net for failing banks on Tuesday in Brussels, redoubling
efforts to avoid an embarrassing delay to the euro zone's
centerpiece crisis reform.
Sabine Lautenschlaeger, vice chair of the banking watchdog and a
member of the ECB's executive board, told the Wall Street Journal
she expected some banks would need to improve their capital
situation as a result of the tests, either by raising funds or
selling assets, without giving a specific number. "It's the last
chance to clean up," she was quoted as saying.
The asset quality review will be followed by separate and wider
"stress tests" of Europe's banks, to see how they would fare under
certain shock scenarios. All results will be released in October.
Estimates of banks' capital shortfall range from 280 billion euros
($390 billion) to as much as 770 billion euros ($1 trillion).
Previous stress tests of leading European banks failed to completely
root out problems in the sector and the scope of the current review
that combines backward looking checks and forward looking stress
scenarios is unprecedented.
Euro zone banks have never before been measured against common
thresholds, such as a single definition of when loans become
impaired, and many have never had their books interrogated in such
detail. Previous tests relied on locally approved data.
"We expect the AQR and stress test to introduce greater transparency
on 'problem assets' and speed up the healing process," said analysts
Many banks have already been raising funds, shedding assets and
writing off bad debts ahead of the review and stress tests. Italy's
Unicredit <CRDI.MI> on Tuesday posted a record 14 billion euro loss
after writedowns and provisions as it moved to clean up its balance
sheet ahead of the ECB's examination.
Unicredit's chief executive Federico Ghizzoni said he was happy
about the ECB's health check following the results, but Francesco
Giordano, finance chief at UniCredit's Bank Austria arm described
the review as "a very demanding process".
"We have also discussed with regulators themselves that it is quite
burdensome because of the intensity of the time in which the work is
done. It is also extremely detailed, which to a certain extent it is
at times a little bit beyond what necessity should be," Giordano
Michael Kemmer, head of the German BDB banking association, struck a
similar tone, saying the work load for all involved was significant
and at the limit of what could be handled.
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Once the results of its review are known, the ECB will push banks to
reflect some of the findings in their 2014 accounts.
Banks will only be expected to change their 2013 accounts in the
unlikely event that the review highlights issues that should lead to
a restatement according to local law, it said.
The ECB's guidelines also set out different scenarios when loans
should be classified as impaired. For example when a debtor has
requested emergency funding from a bank, or if a company that has
taken a loan gets into financial difficulty and experiences a
material decrease in turnover or the loss of a major customer.
As part of the exercise, the teams will also check whether
collateral, for example in the form of real estate, aircraft, ships
or artwork, is correctly valued, with help from external experts or
by updating recent independent market valuations.
Collateral that has not been valued in the previous 12 months will
have to be re-evaluated.
Collateral valuations are one of the biggest sources of uncertainty
for banks in Italy. Sources told Reuters on Friday that the Bank of
Italy was hiring up to five real estate consultants to assess
whether banks are correctly valuing property used as loan
Beyond loans, "level 3 assets" — a broad group of assets that are
difficult to value — will also be assessed. These include
derivatives, assets such as real estate holdings which banks have
acquired through foreclosures, participation in private equity deals
and special investment vehicles.
The ECB will run a more in-depth review of such assets at 29 banks
with material exposures, which include Deutsche Bank <DBKGn.DE>,
Commerzbank <CBKG.DE>, Societe Generale <SOGN.PA>, UniCredit and
"It is expected that, in most cases, fewer than 10 derivative
pricing models will be reviewed for each bank included in the
trading book review, depending on the size of the bank's exposure to
level 3 derivatives," the manual said.
Some banks included in the trading book review will have no relevant
level 3 derivative pricing models to review, it added.
(Additional reporting by Laura Noonan in
Dublin, Michael Shields in Vienna and Kathrin Jones in Frankfurt;
editing by David Holmes and Greg Mahlich)
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