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Sovereign-Debt Test U-Turn Too Late to Save EBA Credibility

December 06, 2011

(Updates with comment from EBA in sixth paragraph.)

Dec. 6 (Bloomberg) -- Less than five months after conducting stress tests that found banks needed to raise 2.5 billion euros ($3.4 billion), the European Banking Authority may tell lenders that they need 40 times that amount to defend against losses on sovereign debt.

The regulator may release updated figures on how much capital lenders should raise to absorb losses from euro-area bonds as early as this week, three people familiar with the matter said. The London-based watchdog’s stress tests in July were criticized for failing to include writedowns on sovereign debt held to maturity.

The EBA “has a fundamental problem, which is that they’ve lost credibility and it’s going to be very difficult to claw that back,” Bob Penn, a London-based financial regulation lawyer at Allen & Overy, said in a telephone interview. “Will anyone pay attention? I’m not so sure.”

European leaders are demanding the region’s banks increase capital after financial firms agreed to accept losses on Greek government bonds. The EBA estimated in October that the region’s financial institutions need 106 billion euros to reach a goal of holding 9 percent of so-called core Tier 1 capital by mid-2012, after marking their sovereign debt to market prices.

Seventy banks were tested in October with data broken down by country. Spanish banks needed 26.2 billion euros and Italian banks 14.8 billion euros in core tier 1 capital, taking into account booking sovereign debt at market prices, the EBA said.

EU Summit, Holidays

A publication date for the bank capital data will be agreed to at a meeting tomorrow of the EBA’s board of supervisors, Franca Congiu, a spokeswoman for the authority said in an e- mail. The figures on banks’ capital needs will be signed off at the meeting, she said.

The timing of the release is complicated by holidays in Italy, Spain, Portugal and Austria and the Dec. 8-9 European Union summit in Brussels and could be delayed until next week, according to two of the people, who declined to be identified because the discussions are confidential.

Regulators may ask German lenders to boost their capital levels by around 10 billion euros, almost double the original 5.2 billion-euro estimate for the country’s banks in October, two people familiar with the situation said last week.

The updated figures take into account sovereign holdings through the end of September, rather than the estimates, which used June data. U.K. banks probably won’t need to raise capital, Andrew Bailey, head of banking supervision at the FSA, told reporters last month.

‘Shrink’ Balance Sheets

The exercise “is likely to compound the forces encouraging banks to shrink their balance sheets,” Huw van Steenis, a banking analyst at Morgan Stanley, said in an e-mail.

By using a capital ratio, rather than setting a specific capital amount to be raised, “it is likely to intensify the credit squeeze into a weakening economy,” van Steenis said.

Banks will likely shrink their balance sheets by as much as 2.5 trillion euros within a year-and-a-half, Morgan Stanley said in a report last month.

Enria yesterday warned against banks trying to boost capital by cutting lending to companies, which might harm the economic recovery. Such so-called deleveraging poses a “serious threat” to growth, he said.

The EBA has been clear that “only the narrowest actions curtailing asset levels” would be allowed to count toward lenders’ capital ratios, Enria said. Capital requirements for banks are set as ratios of their reserves compared with loans and other assets weighted according to their riskiness.

‘Extremely Difficult’

The EBA gave banks until Christmas Day to submit their plans for meeting the capital requirements. The German Banking Industry Committee last month asked for an extension until Jan. 13 because meeting the deadline would be “extremely difficult, if not impossible.”

The purpose of the 9 percent capital target is to improve lenders’ “access to markets,” Enria said. “Only a handful of banks have been able to access medium- and long-term unsecured funding since late June 2011,” he said.

Bankers may have to give up bonuses and shareholders forgo dividends under the plans to meet the tougher EU standards, European Commission President Jose Barroso said in October.

--With reporting from Oliver Suess in Munich, Nicholas Comfort and Aaron Kirchfeld in Frankfurt, Boris Groendahl in Vienna, Maud van Gaal in Amsterdam, Sonia Sirletti in Milan, Karin Matussek in Berlin and Jim Brunsden in Brussels. Editors: Christopher Scinta, Frank Connelly

To contact the reporters on this story: Ben Moshinsky in London at

To contact the editors responsible for this story: Anthony Aarons at

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