Banks face deadline to rerun EU stress tests

European banks have until Friday to rerun their data for newly toughened European Union-wide stress tests that require them to be prepared for additional losses on sovereign bonds.

The European Banking Authority plans in mid-July to release results for the tests, which will assess whether 90 banks have enough capital to survive an economic and housing downturn.

The pan-EU regulator said it had required many banks to resubmit their data “to address inconsistencies and excessive optimism, including the treatment of sovereign exposures”.

People familiar with the process said banks in some countries, such as Germany, Spain and Portugal, had used much more benign assumptions than others, making it easier for them to pass. The EBA has now specified minimum standards to ensure that banks make proper provision for possible losses.

With Greece in crisis and the markets jittery about other EU nations, the EBA is keen to address the possibility of sovereign risk, though it does not officially acknowledge that a country could default.

Last year’s tests did not model for that problem and two Irish banks passed just months before that country’s banking sector collapsed. But the EBA forced banks to factor in the troubles in Ireland, Greece and other southern eurozone countries in two other ways.

For the trading books, banks have to mark sovereign and financial bonds to market, applying specific haircuts that “reflect market developments”, the EBA said. About 20 per cent of troubled sovereign and related financial institution debt is held in this way.

Essentially, the banks are having to calculate the “probability of default” and their “losses, given default” using a formula that assumes that the credit ratings of the most troubled countries and banks would drop by four notches.