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Regulator to Challenge European Banks' Capital Plans

Euro bills at teller window
AP
Euro bills at teller window

The European Banking Authority is to challenge a significant proportion of the capital restructuring plans put forward by the continent’s leading banks to meet tough new capital requirements, say three people familiar with the process.

The regulator said in December that 30 banks needed to boost capital by an aggregate €115 billion to reach a 9 percent target for core tier one capital, a key measure of financial strength.

The banks were given until January 27 to submit plans to the EBA, via national regulators, outlining how they would meet the requirement. The plans will be discussed by the EBA board next week.

According to one person close to the process, as much as half of the measures outlined in those plans do not look credible. There are two particularly contentious tactics being employed — shifting the way in which a bank calculates the risk-weighting of its assets; and promising asset sales that are unlikely to attract buyers. Projected profits for the period to June also appeared over-confident in some cases, given the worsening outlook for the eurozone economy.

Some officials said privately last month that they expected Germany’s Commerzbank, which had an EBA stress test shortfall of €5.3 billion, and Italy’s Monte dei Paschi di Siena, with a €3.3 billion shortfall, to find it particularly difficult to meet the requirements without state aid. Since then, Commerzbank has claimed it has already generated €3 billion of fresh capital. On Friday, German national regulator Bafin echoed that positive expectation.

Only one group, Italy’s UniCredit, has opted for a rights issue to raise capital. All other banks have come up with a combination of asset sales, risk-weighting recalculations, profit retention projections and so-called liability management exercises, involving the buying back of debt that is trading below par-values, a process that triggers an immediate capital gain.

The EBA stress tests, and the capital deficits the regulator identified, have triggered vociferous complaints from banks across the continent. Politicians, particularly in Italy and Germany, and some national regulators have also expressed doubts about the exercise and the danger that it could exacerbate a credit crunch.

Against that background, the EBA appears to have shown a growing willingness to compromise on the details of the capital restructuring process.

The regulator plans to monitor asset sales to insure they are not damaging to the economy and may allow banks some flexibility on the timing to help avoid fire sales. However, the sales cannot be put off indefinitely, people familiar with the process warned.

They also say that while some risk-weighting changes may be aggressive, many are likely to be perfectly legitimate.

As part of an effort to get banks to improve their risk management, global regulators decided that institutions that developed their own models for measuring the probability of default and the likely loss given default could use them to qualify for lower risk weights than banks which rely on the standard method, which assigns flat rates to entire classes of assets.

Many European banks currently use the model method, known as IRB for internal ratings based, for only some of their assets. Faced with a desperate need to reduce RWAs, they are now spending the money to convert to IRB for the rest. Several Spanish banks and Commerzbank are among the institutions engaged in this process.

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