Deflation, emerging market fears set scene for tough EU bank tests

Sun Apr 27, 2014 4:20am EDT
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By Laura Noonan

LONDON (Reuters) - Fears of euro zone deflation, emerging markets turmoil and a determination not to repeat past mistakes mean European regulators are likely to come up with the toughest set of tests for the region's banks that they have ever faced.

The European Banking Authority (EBA) will on Tuesday reveal the crisis scenarios that banks will have to prove they can withstand without resorting to the kind of taxpayer bailouts that all but bankrupted some countries in the 2008-2012 crisis.

Banks that fall short of capital under the imagined scenarios will have to produce a plan to boost their reserves by raising fresh funds from investors, selling assets or hanging on to profits instead of paying dividends.

Banks have already raised billions in capital and made other reforms ahead of the tests, which regulators hope will finally banish any investor doubts about the industry and allow it to refocus on lending to boost growth.

The European economy has rallied since the last round of bank stress tests three years ago and sharply lower borrowing rates for countries such as Greece - which can now borrow five year money at an interest rate below 5 percent against the 20 percent it was paying when the 2011 tests were done - support the idea that the worst of the euro zone crisis has passed.

But with widespread criticism heaped on 2010 and 2011 stress tests for being too soft, and new risks on the horizon, regulators are likely to set tougher conditions all the same.

"The key is that the scenario is at least as deep and dark as the great recession, the financial crisis of 2008/2009," said Mark Zandi, Philadelphia-based chief economist at Moody's Analytics. "You can easily conceive a scenario as severe as what we went through."

AS TOUGH AS THE U.S.   Continued...

European Central Bank (ECB) President Mario Draghi pauses during the monthly ECB news conference in Frankfurt April 3, 2014. REUTERS/Ralph Orlowski