European banks will have six to nine months to cover capital shortfalls that are uncovered by forthcoming stress tests and an ongoing asset quality review, the European Central Bank (ECB) says.
The European Banking Authority (EBA) announced the methodology and scenarios for the EU-wide stress tests Tuesday, and the ECB explained to banks how capital shortfalls must be addressed following these assessments. The results of those tests are slated to be published in October.
At the same time, an asset quality review is already underway. “Reviews of collateral, provisioning and exposures have started and will be completed by the end of the summer,” said Danièle Nouy, chair of the supervisory board of the single supervisory mechanism (SSM).
The results of the review will be incorporated into the stress test results. “This feature is an enhancement not seen in past large-scale stress test exercises,” said Nouy. “Following the publication of the results, the ECB will request banks to submit capital plans detailing how shortfalls will be covered.”
The ECB said that capital shortfalls arising from the asset quality review and baseline stress test scenario must be covered by common equity Tier 1 capital instruments. Whereas shortfalls under the adverse scenario can be covered in other ways, subject to specific constraints on the capital instruments that may be eligible to address these shortfalls. Banks will have six months to cover shortfalls under the baseline scenario, and nine months for those identified in the adverse stress test scenario.
“In anticipation of any shortfalls, banks should start to consider what private sources of capital could be raised as a result of this exercise and plan accordingly, taking into account that the capital plans they will have to present can include retained earnings, reduced bonus payments, new issuances of common equity, suitable strong contingent capital and sales of selected assets at market prices,” said Vitor Constâncio, vice president of the ECB.