BRUSSELS (MNI) – Future ‘stress tests’ of European banks should be
“recalibrated” to stop the exercise from overly burdening the sector and
government finances, a senior European banking regulator said on Monday.

“Given that the introduction of Basel 3 already requires increased
capital and in light of the changing balance of risks of procyclical
regulatory action, it would be sensible to recalibrate the European
approach to stress testing in the next period,” Matthew Elderfield,
alternate chairman of the European Banking Authority (EBA) and Deputy
Governor of the Central Bank of Ireland, said in personal remarks
addressed to the German parliament.

The EBA’s decision to postpone its next stress test until 2013 will
provide “breathing space” for banks and allow for Europe’s crisis
response to take effect, the senior regulator said. Successful
implementation of fiscal discipline and an adequately resourced and
flexible firewall could also reduce the amount of capital banks need to
raise, he added.

“We should use a breathing space to refine the policy instruments
at hand in a way that can help break the feedback loop that is doing so
much damage to all the member states of the Eurozone,” Elderfield said.

Banks in many countries could probably justify dipping into their
capital reserves under Basel III’s methodology but these buffers are not
yet in place, he said, adding that many banks are racing to meet the new
capital requirements ahead of the five-year transitional period because
markets are demanding that banks raise more capital, and more quickly,
than are regulators.

“In this respect, what the regulator has given- a transitional
period to ease the impact of the new rules- the market has taken away,”
said Elderfield.

“I fear that trying to satisfy insatiable market expectations of
conservatism in a stress test risks being very procyclical,” he said,
referring to the negative effects on lending that raising capital
requirements during an economic downturn would have.

A stress test last year to see how Europe’s banks would cope with
an economic shock and substantial write downs of troubled sovereign debt
holdings led the EBA, Europe’s new banking regulator, to identify a E115
billion capital shortfall that Elderfield said came on top of and
overlapped with the new Basel III requirement.

“Interestingly, the US stress tests are now focused on dividend and
share repurchase approval rather than closing a capital gap in a
prescribed timeline,” he said.

Elderfield also said that he believed that greater flexibility for
Europe’s crisis funds, was an “equally important objective” to raising
their capacity.

He described as “interesting” a suggestion made by the Federation
of German Industries that Europe could help support Greece’s struggling
banking sector through more investment rather than more loans.

“Finding mechanisms for investment in banking systems without
adding to sovereign debt must surely be a desirable policy goal to be
considered carefully. This might be done through European firewall
mechanisms or other structures,” he said.

–Brussels newsroom: +324-9522-8374; pkoh@marketnews.com

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