* Prolonged scrutiny of banks will create more uncertainty
* Market jitters could ramp up cost of funding
* Delays expected as ECB/EBA timetable seen as unrealistic
By Aimee Donnellan and Helene Durand
LONDON, Oct 15 (IFR) - The looming ECB review of bank health
in the eurozone is unnerving lenders and investors alike, and
risks undoing the relative calm in the bond markets over the
With the European Central Bank set to assume supervision of
eurozone banks in November 2014, there are concerns on all sides
about both the timing and substance of the tests - and some fear
the exercise will expose a very large capital hole that will
have to be quickly mended.
"With the stated objectives, I think it's intractable," said
Adrian Docherty, head of banking advisory at BNP Paribas.
"The outcome is bound to be a fudge, though I don't think
that will damage ECB credibility. The risk is that things will
drift on, becoming increasingly painful and perhaps
counterproductive. We don't want this to be 'death by
Scrambling to get to grips with Europe's largest bank
balance sheets, the ECB will carry out what it calls an asset
quality review (AQR) before stress testing the institutions with
the European Banking Authority.
But the path from here to there looks more and more like a
minefield as the ECB has yet to give banks guidance on how
assets will be examined, whether half or full-year results will
matter, and what types of loans will be examined - all of which
will be crucial in determining whether a bank passes its test or
The legal and regulatory agreement for the ECB to take the
reins of Europe's banks has already been delayed for roughly
three months and was only signed today (October 15). Meanwhile,
the ECB is set to present the methodology for the bank
assessment by the end of October.
From the time the ECB gets the official nod that it will be
responsible for Europe's banks, it will only have one year to
carry out the AQR and stress tests before the November 2014
takeover - and already the delays seem to have shaken some
investor confidence, raising the possibility of more volatility
in the meantime.
Even if the banks welcome additional time to get their
balance sheets in order before next November, some market
participants believe the delay will shine an unwelcome spotlight
on Europe's weakest banks.
"Although certain countries may welcome additional time to
get their balance sheets in order, any delays from banks will be
taken as negative and seem like they are scared about what they
might find," said Robert Montague, a senior financials analyst
at ECM Asset Management.
WAIT AND DON'T SEE
Looking at the road ahead, it's easy to see why banks are
Although banks now have a timeline for the release date of
ECB methodology, the central bank's inability to give lenders an
earlier heads-up on the review criteria - combined with the
delay in signing the agreement - means the whole process is
being dragged out over an even longer period.
Moreover, while the review is expected to highlight capital
holes in bank balance sheets, politicians have yet to agree on
where the funds to fill those holes will come
NOT THE BEST TIME
Investors are already noting that the complicated process
comes at a time when Europe's banks have been able to enjoy a
period of relative stability coming out of the eurozone crisis.
There has been renewed investor appetite for their debt over
the past year, with even weak lenders able to beef up their
capital via contingent convertibles (CoCos).
And the cost of insuring against European bank debt default
has decreased materially since 2011. The senior and subordinated
indices have tightened by 220bp and 400bp respectively.
"We have seen European bank spreads decrease a lot over
recent months and any delay in the AQR and stress tests could be
negative," said Vinod Vasan, global head of financial
institutions group, debt capital markets at Deutsche Bank.
And while many expect the banks of Greece, Portugal, Ireland
and Spain to come out worst in the eventual stress tests, others
in the market are looking elsewhere.
A treasurer at one of Europe's weakest banks said that much
of the market is focusing on France and Italy.
Recent bitter experience in Europe underscores the
importance of making sure the tests are carried out properly so
that investors do have that knowledge.
In 2011, the European Banking Authority (EBA) allowed banks
like Dexia, Bankia and SNS Reaal to glide through examinations.
All of them later failed and - in the case of SNS -
bondholders ended up getting bailed in.
"Investors need to know a bank's solvency situation," the
treasurer said. "If not it would be difficult to invest in any
(Reporting by Aimee Donnellan and Helene Durand; Editing by
Alex Chambers, Marc Carnegie and Julian Baker)