The European Central Bank will finalise the selection of portfolios for the Asset Quality Review in mid-February.
Once the portfolios have been chosen, the national competent authorities and their third party specialists will review the banks’ processes, policies and accounting practices, analyse their credit exposures and provisions, and evaluate their collateral and real estate assets.
The full AQR methodology will be released in the course of the first quarter of 2014.
“The general use of private sector firms is necessary not only because of the magnitude of the exercise but also to enhance its independence and credibility,” the ECB said this week.
The exercise will use a definition of non-performing exposures that has been agreed with the European Banking Authority, which means that every material exposure 90 days past due will be classified as non-performing even if not recognised as defaulted or impaired.
The comprehensive assessment will also revalue the most important level-3 securities (assets that are illiquid and difficult to value) whenever banks have material exposures in their banking or trading books. For banks with the most important trading books, it will also involve qualitative reviews of the core trading book processes and quantitative reviews of the derivative pricing models.
The ECB also confirmed that it will apply the parameters for the stress test released by the EBA on January 31. Together with the asset quality review (AQR), the stress test forms part of the comprehensive assessment. The assessment aims to enhance the transparency of the balance sheets of significant banks and to rebuild investor confidence prior to the ECB taking over its supervisory tasks in November 2014.
Vítor Constâncio, Vice-President of the ECB, said: “Preparations for the stress test are well underway and we are confident that, in close coordination with the EBA, the outcome will be transparent and credible, boosting the European banking sector.
“We have noted that capital and provisioning measures have been taken since the exercise was announced. Banks are front-loading preparations for the comprehensive assessment, and are strengthening their balance sheets, which is a welcome development.”
For the stress test element of the comprehensive assessment, as announced by the EBA, the capital threshold for the baseline scenario will be 8% Common Equity Tier 1 (CET1), whereas for the adverse scenario, a threshold of 5.5 per cent CET1 will apply.
Sovereign exposures in the held-to-maturity portfolios will be treated in the same way as other credit exposures in that portfolio, i.e. the impact of the scenarios on the loss and default parameters will be calculated and will result in larger provisions.
Meanwhile the same types of securities in the available-for-sale (AFS) and held-for-trading (HFT) portfolios will be market-to-market, in line with the scenario employed.
The effect of the gradual phasing-out of AFS prudential filters on sovereign exposures will be fully disclosed. In addition, bank holdings of sovereign exposures, and their respective maturities, will also be disclosed in full.
The ECB expects the scenarios for the stress test to be sent to the banks by the EBA at the end of April 2014.