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ECB gets tough on risky bank assets

ECB releases details on bad loans as part of AQR

The proposed banking union for the 18 countries that share the euro took another step forward on Tuesday with the European Central Bank (ECB) giving further detail of its stress tests for the region's banks.

An asset quality review started in earnest last November with the bloc's regulator selecting the 128 banks that would come under its portfolio. Phase 2, as it will be known, came into action on Tuesday and will see the execution of these rigid stress tests -- whereby the banks' books will be examined to see how well they could withstand a variety of economic shocks.

(Read more: Greece urged to conclude talks as funding gap looms)

Each national banking authority will be required to send a letter to their country's leading banks outlining any areas where the bank is found to be outside accounting principles, the report said. This would also show the required solutions that the bank would be expected to take. This would lead to expected adjustments to available capital or a change in procedure for lost loans. A bank might also have to take into account ECB views on asset valuation if the central bank is unhappy with its risk assessment practices.

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The rigorous testing involves ten different elements that were outlined by the ECB report published on Tuesday morning. This included banks' accounting practices, the value of the assets on their balance sheets, their exposure and intricate details of each loan that it has provided. It also says that banks will need a "credit file review" which highlights where losses might occur if a loan were to turn bad.

"The AQR (asset quality review) is a prudential exercise, focused on providing the necessary clarity on the banks that will be subject to the ECB's direct supervision," the report stated.

Under examination will be 3.72 trillion euros of risk-weighted assets, according to the ECB, and an average of 1,250 loans per bank will be reviewed by August, with even more predicted for Europe's biggest banks.

(Read more: Biggest risk for 2014? Stress tests: Van Steenis)

The ECB's treatment of 'level 3 assets', will receive special attention, it said. These are a group of assets that are difficult to value and contain the most risk, with only a small portion of the 128 banks having this exposure.

Olly Burrows, senior banks analyst at Rabobank International said that these tests would not reveal information that is necessarily secret, but would offer more detail and greater transparency.

"There is not a lot of surprising details in there," he said, responding to Tuesday's report. "I'm not concerned about any of (the banks)."

Following the global financial crash of 2008, a sovereign debt crisis raged across the continent in 2011 with bailouts needed for many of the euro zone's struggling nations. Austerity followed with tough fiscal tightening required by some of the more indebted countries. Despite opposition and a rise in fringe politics, the underlying fundamental data in many euro zone countries have improved. These flickering signs of growth have helped the bloc manage to exit a prolonged recession.

(Read more: ECB ups 2014 growth forecast, inflation to pick up slowly)

In order to stamp out the possibility of this financial turmoil ever returning, policymakers and regulators have devised plans for banks to form a greater bond. All 128 banks will come under the supervisions of the ECB in a grand banking union. The natural progression of this union would lead to closer political integration between the 18 nations.

By's Matt Clinch. Follow him on Twitter @mattclinch81.