The European Central Bank (ECB) hopes to begin work on an asset quality review of major banks in the 17 eurozone countries later this year. The review will take a detailed look at whether they've set aside enough cash to deal with debts unlikely to be repaid, so the ECB can stand over the state of the banks' before it becomes their official supervisor in late 2014.
National supervisors elsewhere in the EU will conduct a similar review for the non-eurozone countries. Both reviews, which will be coordinated by pan-EU regulator the European Banking Authority, will focus on 'problem categories' of loans in individual countries, looking at areas like shipping, commercial real estate and mortgages in some markets.
The stress tests are more forward-looking, and examine how banks would cope with future scenarios like a collapse in economic growth, a rise in interest rates or another credit crunch that made it far harder for them to access funding, essentially answering a different question.
Rather than having a pass/fail mark, like previous tests, the 2014 version will rank banks against various yardsticks. Those could include examining their coverage ratios, or how many cents banks have set aside to cover potential losses for every euro of bad loans. The EBA is also encouraging more transparency in the way banks judge the riskiness of their portfolio, a key input into the capital ratios. To further this, the stress test could include benchmarks showing how conservative or aggressive banks' risk weighted assets treatments are.
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