Finance officials from the 27 member states held very low-key talks in Brussels yesterday (22 July) in an attempt to co-ordinate governments' reactions to the results of bank stress tests on the sector's resilience to another economic downturn and sovereign debt crisis.
The results will likely reveal liquidity problems in German, Italian, Greek and Spanish banks, according to early predictions made within the sector. The Committee of European Banking Supervisors (CEBS) has said it will publish the results of the tests, carried out by national supervisors, at 6pm Brussels time today, after European markets have closed.
Officials were reluctant to reveal details of how governments plan to react to the results. Ministry officials made a last-minute decision to publish the test's methodologies a few hours ahead of the actual results, EU sources said.
This may prove an important step as the tests' methodologies have been heavily criticised for not using the bleakest possible scenarios, like a Greek default or windfall prices in the Spanish real estate market (EURACTIV 02/07/10).
"Everybody is talking to everybody on how to react to what CEBS will say tomorrow," an EU source said on the eve of the results, refusing to divulge any more information on the content of the talks.
Governments were under pressure yesterday after the International Monetary Fund called for further transparency in the tests and for them to be extended to banks beyond the 91 already included.
During yesterday's teleconference, the ministers allegedly also discussed whether they would ask banks to provide a detailed breakdown of their sovereign debt holdings, the show of transparency that investors and the IMF have been calling for.
EU diplomats say governments will be compelled to react if the results show weaknesses in their banks.
"If the results are bad, it is unthinkable that the governments concerned will say nothing," a diplomat said, adding that "it is the credibility of the EU which is at stake".
The diplomat also underlined that stress tests were chiefly a communication tool.
Capital of last resort
Analysts predict that governments will steer clear of injecting banks with fresh capital as this would spark fury among taxpayers who are already reeling from spending cuts in many EU countries.
"Governments will use every possible means to avoid the 'money for recapitalisation in the face of austerity cuts' debate," a financial government adviser, Sony Kapoor, told EURACTIV.
Kapoor predicts that governments will likely either use existing capital buffers, like Germany's SoFFin, or unleash further government guarantees to plug balance sheet holes.
Some, such as Germany, have dry powder left in their previous recapitalisation programmes. Others will ring-fence bad assets [like Ireland's National Asset Management Association (NAMA)], and still others will provide contingent support in the form of more guarantees, he explained.
"Upfront transfer of government money in the form of fresh capital will be an absolute last resort," Kapoor added.
An EU diplomat from a large member state agreed with Kapoor, saying that banks that fail the test will not necessarily need to be recapitalised.
"Other options are available," the diplomat indicated, saying that banks could for example envisage reshuffling their exposure to certain categories of asset.
Testing Tier 1 capital
Market watchers will be bombarded with information today as aggregate results will be published by the EU body, the Committee of European Banking Supervisors, at 6pm tonight, with bank-by-bank results coming close behind.
The 91 banks – or 65% of the bloc's banking sector – will be tested on their Tier 1 capital ratios and their resistance to further sovereign debt shocks.
Banks Tier 1 capital, which measures core capital against total assets, like outstanding loans, will have to maintain a minimum ratio of 6% in order to pass the test.
Tier 1 capital ratios will be tested under three scenarios at the end of 2011, after two years of economic deterioration and after with an additional sovereign shock.
Major listed banks are expected to pass, but the test results are expected to show the biggest problems lie with smaller players such as the Spanish 'caja' savings banks and German landesbanks, which are mainly unlisted.
In tests run by Citigroup, Germany's landesbanks faced an estimated funding gap of €11bn to reach the 6% target, a figure easily absorbed by the government's €51 bn recsue fund, SoFFin, argue analysts.
According to calculations made by Reuters Breakingviews, Germany's Landesbanks have an average core Tier 1 ratio of only 5.9% which analysts say has already put them at a disadvantage in the exercise.
Barclays Capital estimates that the tests will leave German, Greek and Spanish banks in need of an additional capital injection of up to €85bn.
Spanish savings banks, or cajas, may require €36bn, German landesbanks could need €34.5bn, while Greek banks may have to raise €8.6bn, according to Barclays' calculations.
Australian bank Macquarie on Wednesday listed those banks it felt might not be able to resist severe shocks in the future, among which were Germany's Postbank, Banco Popolare of Italy, BCP of Portugal and Spain's Sabadell.
Four Greek banks – the National Bank of Greece, EFG Eurobank, Alpha Bank and Piraeus Bank – were also on Macquarie's list.
German lender Hypo Real Estate has reportedly failed the stress test, which was of little surprise since the bank had asked SoFFin for an additional €2 billion in fresh funds.