EU Bank Stress Tests About to Get Tougher

Stress tests on European Union banks this year will use tougher criteria for measuring capital than last year, according to details released by the European Banking Authority Friday.

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The EBA agreed a Core Tier 1 capital ratio of five percent of risk-weighted assets as a threshold on whether a bank passes or fails the tests, compared with a Tier 1 capital ratio of six percent last year.

The criteria for calculating Core Tier 1 "will be applied consistently across al countries participating in the exercise," the EBA said in a statement.

This year, 90 banks making up about 65 percent of the European Union's banking system will take part in the tests. This figure includes all of last year's 91 banks, as some have merged or ceased to exist, plus new banks in Austria, Denmark, Ireland and Norway.

Core Tier 1 (CT1) capital will include only instruments "of the highest quality," the EBA said.

It said the commercial instruments included in CT1 have to be simple, issued directly by the bank itself and must be permanent and able to absorb losses if the situation requires it.

Debt-equity hybrid instruments – an instrument that German banks were insisting should count as capital, according to press reports – or existing preference shares will not be part of CT1, EBA said.

The five percent threshold is not a legal minimum requirement, the EBA said.

"However, supervisors across the EU have reached an agreement that a higher threshold than the legal minimum is necessary in assessing the resilience of banks in adverse circumstances if credibility and confidence in the banking sector is to be restored," it added.