EU Banks Urged to Boost Capital as Stress Test Doubts Voiced

May 13, 2014 4:49 am ET

(Updates with Societe Generale in ninth paragraph. For European debt news, click here.)

May 13 (Bloomberg) -- European banks are being urged to boost their ability to withstand losses before the conclusion of a stress test that is drawing criticism for its design.

Axel Weber, the chairman of Zurich-based UBS AG and a former head of Germany’s Bundesbank, said yesterday that stress- testing banks that have depleted capital is akin to expecting a patient recovering from a heart attack to pass a rigorous physical exam. Moody’s Analytics Inc. said last week that the tests aren’t internally consistent.

“If some of the patients come just out of the intensive ward, and they’ve just had a massive cardiac arrest, looking at their medical is good, putting them under stress is less good,” Weber said at a conference organized by the Austrian central bank in Vienna. “That’s why upfront, early recapitalizations are what is needed. Once you actually have all the medical data out there, it is very hard to get capital in the market.”

The European Central Bank is leading the charge to prove the region’s banks are robust before it takes over financial supervision in November, and has squeezed an unprecedented Asset Quality Review and a stress-test into its year of preparation. That pressure has led to some disquiet about the compromises needed to get the job done on time.

Share Sales

“In broad terms, you would naturally do the AQR first, take your lessons out of that, then do your stress test,” Elke Koenig, the head of Bafin, Germany’s financial regulator, said at the Vienna event. “Unfortunately, that’s not the option here because of the time limitations.”

The AQR and stress test are the final stages in the ECB’s Comprehensive Assessment. The central bank has said it will communicate the results as a “distilled” whole in October.

As that date looms, lenders from Italy’s Banca Monte dei Paschi di Siena SpA to Austria’s Raiffeisen Bank International AG have already completed share sales or plan them to strengthen their balance sheets. By the end of April, the region’s lenders had taken measures worth about 104 billion euros ($143 billion), including asset sales, convertible debt issuances and share sales, ECB Vice President Vitor Constancio said yesterday.

“As a result, confidence in the euro-area banking sector has improved,” he said in Vienna. “Since the first quarter of last year, banks’ stock prices have risen at almost double the rate of the average market growth.”

‘More Difficult’

A gauge of euro-area bank shares has climbed 21 percent since the start of April 2013, compared with a gain of 15 percent for the Stoxx Europe 600 index. Societe Generale SA, France’s second-largest bank, said today it will boost the portion of profit it pays to shareholders and increase return on equity, a measure of profitability.

Constancio said about 34 billion euros has been raised or will be raised through issuance of publicly listed shares. Other measures include 15 billion euros through contingent capital hybrids and 19 billion euros in additional provisioning.

That process should continue, rather than lenders waiting until the results of the assessment are announced and then being required to submit formal capital plans to their supervisors, said Bafin’s Koenig, who oversees some of Europe’s largest institutions including Deutsche Bank AG and Commerzbank AG.

“Banks that think they might have an issue have hopefully heard the signal and are trying to raise capital while the sun is shining,” she said. “It might get more difficult over time.”

Daniele Nouy, who chairs the ECB’s new Supervisory Board, said at the conference that capital plans will have to show how banks plan to tap private sources of capital first.

Adverse Scenario

Koenig also said some German banks may have difficulty passing the adverse stress-test scenario, which was unveiled by the European Banking Authority and ECB last month. The model simulates turmoil that starts in a global bond-market rout and costs the region’s economy a cumulative 7 percentage points in lost output over three years.

While theoretically tougher than either of the two previous such exercises run by the EBA, the adverse scenario is “sloppy,” Mark Zandi, an analyst at Moody’s Analytics, said in a conference call on May 7. “Given that there’s a lot of countries involved and the complexities, that’s probably understandable. But it doesn’t hang together particularly well.”

The methodology also assumes that lenders will be able to roll over the funds they received from the ECB as crisis-era longer-term refinancing loans. That works against creating a level-playing field in the region’s banking system, according to Koenig.

“This is something that will create imbalances between those banks that are market-funded as of today, and those that are still availing themselves of LTROs,” she said. “The ECB will have to address this in the results.”

--With assistance from Boris Groendahl in Vienna, Stefan Riecher in Frankfurt and Fabio Benedetti-Valentini in Paris.