A top EU regulator called for tougher stress-testing of the region's banks as countries remained locked in dispute on how strict the checks should be. "I am very much aware this year we will need to do a much stronger and reliable and credible exercise," said Andrea Enria, who is set to become the chairman of a pan-European agency that will manage the exercise.
"The scenarios will have to be stronger and more severe than last year," he told EU lawmakers on Tuesday, while also defending discredited tests done in 2010 as having fallen victim to rapidly changing circumstances. Those checks were condemned after they gave Irish banks a clean bill of health - only months before an EU-IMF bailout to help Dublin cope with problems at its biggest lenders.
But as Enria met representatives of the European parliament to persuade them to approve his appointment as chairman of the European Banking Authority, a row between European countries about the stress tests rumbled on. The most contentious pointe, flagged earlier this month by EU financial reform chief Michel Barnier, is whether a possible future restructuring or default on debt by Greece, for example, should be one of the test scenarios for banks.
Many fear that if such a scenario is included, it might send a signal to investors that a restructuring is imminent and undermine confidence. Another controversial issue is whether banks should be tested for their ability to deal with a liquidity crunch, in the event of borrowing difficulties caused by a market squeeze.
But Enria said any checks on liquidity would not be part of the central stress testing, which could determine whether or not banks need to recapitalise. "(Liquidity) is very difficult," he said. "We cannot embody liquidity and credit risk in the same stress-test exercise but we need to have a separate exercise on liquidity."
The European Banking Authority was launched in January and will have the final say in overruling national regulators like Britain's Financial Services Authority. But critics fear its small staff of just 30 will not be able to cope. Lawmakers in the EU parliament postponed a decision on waving through the appointment of Enria, as well as two others proposed to lead new insurance and markets watchdogs.
Flagging concerns about the agencies' budget and staffing, Sharon Bowles, who heads the influential EU parliamentary economic and monetary affairs committee, said the "selection procedure has so far been below par". It is, however, unlikely the parliament will ultimately block the appointments.
Last July, 91 EU banks were tested to assess how they would cope if lending - such as home or commercial property loans - turned sour. But the studies did not consider the risk of a bank being forced out of business if it struggled to get credit itself or if savers withdrew deposits.
Both factors exacerbated the difficulties of Irish banks, whose mounting loan losses and funding difficulties eventually forced the Irish government to seek an 85 billion euro ($114 billion) EU/IMF bailout late last year. With investor confidence in the eurozone shaken by indecision over how best to help countries that find it hard to borrow, officials in the European Commission hope a new round of stress tests can prove the bloc's financial system is sound.