* National supervisors briefed by ECB team on tests on Monday
* ECB test timetable is sacrosanct - source
* Banks that cannot meet deadlines to be judged conservatively
* Test guidelines and templates "very prescriptive"
LONDON, Feb 19 (Reuters) - Euro zone banks face penalties if they miss deadlines set by the European Central Bank in its landmark review of lenders' balance sheets, national supervisors were told at a Frankfurt meeting, according to sources familiar with the talks.
The ECB's asset quality review (AQR) is part of a wide-ranging examination of 128 of the region's largest banks to address lingering doubts about their health and avoid nasty surprises once it starts supervising them from November.
The exercise aims to encourage banks to recognise losses on loans or investments that have gone bad, allowing them to regain investors' trust and freeing up capacity to grant new loans to help the euro zone's fragile economic recovery.
Several hundred experts from national supervisors across the 18 euro zone countries and professional firms advising them gathered at the ECB's Frankfurt headquarters on Monday for an all-day session spelling out the road ahead for the bank tests.
"Deadlines are sacrosanct," said one source familiar with the meeting. If banks cannot fill out the complex templates of information on time, testers will use "conservative proxies" to make an educated guess about the state of their books, the source added.
The treatment would likely penalise banks because the conservative estimates of factors influencing an asset's value would likely lead to a lower value than the reality.
More conservative assumptions would ultimately make a bank's position look worse, and force weaker lenders to raise more capital than they would otherwise have to.
Confidence in the sector remains fragile despite more than 1 trillion euros ($1.4 trillion) of state support since the financial crisis and the euro zone's debt problems underlined the risky relationship between over-indebted governments and the banks who buy many of their sovereign bonds.
The overall deadline for the bank checks is October, so results are known when the ECB becomes the region's supervisor. There are other deadlines along the way, but those can vary.
This week banks were asked to fill out comprehensive templates on the portfolios being examined, and were given different deadlines based on the complexity of the data sought.
The second source confirmed the importance of the timetable was a very strong message of the meeting and said banks were being encouraged to provide the data on time in a variety of ways, including some that applied a lower valuation to an asset where less information is disclosed.
Banks would not be rewarded for providing data comprehensively and quickly, but those that do not fully comply could face additional burdens, a separate source familiar with the process said. Those additional burdens could include having to provide information on a larger sample of loans.
The ECB declined to comment on the meeting, which the first and second sources said was largely hosted by Oliver Wyman, the consultants appointed to project manage the asset quality review on behalf of the central bank.
National authorities will work closely with the ECB in reviewing banks. The timetable for the examination - which also includes a stress test looking at how banks would fare in a future crisis - has been described as ambitious from the off, since it is the most in-depth assessment of the banks to date.
"They've tried to identify key areas of detail where people might struggle," the second source added. "They've indicated a flexibility around solutions ... but it's not a good idea to just say 'we haven't got it'."
The meeting also discussed at length the prospect of ECB supervisors being able to inspect the assets of eurozone banks that are located outside the common currency area. The first two sources said there was no clear conclusion to those discussions.
Much of the day's meeting was taken up with detailed discussion of a 247-page guide to the AQR. "What came across was the immense amount of work that's been put in," said the second source. "There's really, really detailed guidance and templates - it's very, very prescriptive."
Follow up briefings between the ECB and national supervisors and advisers are planned for March 3 and March 17, the source said.
(Editing by Pravin Char)