EU to put banks through Brexit mill in toughest stress test yet

By Huw Jones

LONDON (Reuters) – European Union banks will face the toughest “stress test” of their ability to withstand theoretical shocks this year, including the impact of Britain’s exit from the bloc, the EU’s banking watchdog said on Wednesday.

While there will be no pass or fail mark for the 48 banks taking part, the outcome will shape capital requirements policed by regulators like the European Central Bank (ECB) which supervises 33 of them.

“The stress test is designed to provide supervisors, banks and other market participants with a common analytical framework to consistently compare and assess the resilience of EU banks to economic shocks,” the European Banking Authority (EBA) said.

The “adverse scenario” of the bi-annual health check is an 8.3 percent cumulative fall in growth by 2020 from the “baseline” scenario based on real central bank forecasts.

Under the test scenario, which the EBA said is tougher than the that used by the Federal Reserve for its health check of U.S. lenders, inflation falls 1.9 percent, unemployment jumps by 3.3 percent and home prices tumble on aggregate by about 19 percent, all by 2020.

For the first time the EU test will reflect new international accounting standards that force banks to make up front provisions on loans in case they turn sour.

The major book-keeping reform applies lessons from the 2007-09 financial crisis that found lenders too late in finding cash to cover defaulting loans.

The test also looks at how banks could cope with a general economic downturn, increased market volatility and political uncertainty that could theoretically be triggered by Britain leaving the bloc in March 2019.

“The adverse scenario encompasses a wide range of macroeconomic risks that could be associated with Brexit.”

It echoes a move by the Bank of England in its own test last year to look at the potential impact of a “hard” Brexit or Britain leaving the bloc without new trading terms.

The EU test will also assume an abrupt and sizeable repricing of risk premium in global markets, and the impact of weak growth and poor profitability.

“This will affect, in particular, banks in those countries facing structural challenges in their banking sector,” the EBA said.

Italian banks were among those who failed the EBA’s previous tests as they struggle with poorly performing loans.

Other factors include new worries over public and private debts, and how lenders would cope with a sell-off in assets by non-banks which sent assets they held plummeting.

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