FRANKFURT – The European Central Bank on Sunday will reveal the results of a yearlong search through the books of Europe’s 130 biggest banks, a key part of the region’s effort to recover from its debt and economic crisis.
The review aims to weed out banks that are hiding financial problems that keep them from lending to businesses at affordable rates. Companies need the loans to invest and hire if Europe’s economy, which didn’t grow at all in the second quarter and has unemployment of 11.5 per cent, is to improve.
Banks that flunk the review could be forced to raise money, restructure or be sold off. That could cause some market turmoil in the short term as banks scramble to find cash from investors or governments.
But in the longer term, the hope is that this will create stronger banks. In Europe, businesses are more dependent on bank loans than in the United States, where companies more often raise funds through bond markets.
Here’s a brief guide to the test:
— It reviews the banks’ loans, holdings and investments as of the end of 2013.
— Examiners looked at whether the banks’ holdings are worth what the banks claim. It was a huge job, which is why it took a year. For instance, officials sized up 119,000 debtors for their ability pay. They valued 130,000 collateral items such as buildings and real estate to see if the collateral was worth enough to protect the bank against any failure to repay the loan.
— After the review, banks are expected to maintain a capital ratio of 8 per cent. Capital ratios measure the amount of capital a bank has against the risky investments it could suffer losses on. A higher ratio means a thicker financial cushion and a stronger bank.
— Not all banks that fail the review will have to raise new money. That’s because some banks will have raised money since the end of 2013, the date when the ECB started looking at the figures.
— Banks were also put through a stress test, a simulation to see what would happen to their finances in a three-year economic downturn with plunging bond prices and gyrations on foreign exchange markets.
— Under stress, banks had to maintain a capital ratio of at least 5.5 per cent.
— Banks found short of capital have two weeks to tell the ECB how they plan to close the gap, and then six to nine months to actually do it. One way to raise capital is by issuing shares. Banks found to be in big trouble could wind up restructuring or being sold.
— Independent experts estimate several banks will fail, though it is not clear how many will need to raise new money. PIMCO, the bond fund management company, estimates 18 banks will need to raise new money.