EU sets new loan rules ahead of stress tests

EUROPE’S banking authority has issued new rules setting out how banks must classify troubled loans ahead of so-called “stress tests” next year.
The new European Banking Authority (EBA) definitions replace a patchwork of different definitions that were applied in the various European states in the last two rounds of stress tests.

The EBA said that the new standards would “promote consistency in the process” and added that “remaining doubts about the quality of assets across the EU may be alleviated”. In a statement, the regulator has set out standard definitions for poor loans and “forbearance”, or loans that have been given leeway by banks.

The new definitions class a loan as “non-performing” when a repayment is more than 90 days overdue or when repayment is unlikely.

That is already the definition used here, according to guidelines issued by the Irish Central Bank in May this year.

A second rule defines “forbearance” to be happening when a bank has allowed the borrower to skip or reduce payments, but states that a loan where forbearance is applied should not automatically be classed as “non-performing” – and trigger the lender having to set aside cash to compensate for anticipated losses.

The Irish guidelines appear to go further, making it clear that the Central Bank here regards loans where forbearance is being applied as risky, by definition.

The new EBA definitions for a problem loan will be applied when the European Central Bank (ECB) oversees an asset quality review (AQR) of the main eurozone banks that will probe whether lenders have fully faced up to their bad loans.

The ECB is due to announce the terms and details of next year’s stress tests on Wednesday.

Tougher

All of the main banks here will be subject to the review, but the initial phase in that process – the so-called AQR – is already under way here because officials from the European Commission, ECB and IMF wanted Irish banks’ assets assessed before the end of the bailout.

Similar AQRs will roll out in the rest of Europe next year. They will be followed by tougher “stress tests” that will look at how banks can cope with potential losses into the future. The big push for the common definitions to be applied by the EBA comes because previous bank stress tests have been widely criticised for failing to identify the scale of the banking crisis.

The EBA has yet to say what the “pass” threshold for the tests will be.