European Banks Could Take Their Hits Early; Banks Face Up to Next Year’s Asset Review by ECB

European Banks Could Take Their Hits Early

Banks Face Up to Next Year’s Asset Review by ECB

ANDREW PEAPLE

Nov. 28, 2013 1:05 p.m. ET

European banks could be in for a painful end to 2013. European banks are already facing up to a huge potential capital shortfall next year, thanks to several regulatory pressures. The European Central Bank will carry out an asset quality review aimed at ensuring banks’ balance sheets conform to uniform rules in areas like bad loans; stress tests will examine how robust banks might be in a downturn.That’s not the banks’ only problem. They also need to comply with minimum capital requirements under Basel III regulations; and ensure they meet leverage ratio rules designed to make them less reliant on borrowed funds. In sum, European banks could need to plug a €280 billion ($380.21 billion) capital gap, according to a report by PwC. Technical adjustments could reduce the gap by around €100 billion. But banks could still have to raise €180 billion from new capital raising or restructuring, PwC reckons.

Rather than wait for the ECB, banks could try to get ahead. Already this year European banks have issued €60 billion of new equity, according to Thomson Reuters data, up from €30 billion in the whole of 2012. Banks like Barclays BARC.LN +1.18% and Deutsche BankDBK.XE +1.34%

have undergone sizable rights issues.

But the process is far from complete. One implication is that banks could use upcoming fourth-quarter results to clear the decks, so that their balance sheets anticipate as far as possible the rules they expect the ECB to apply in its asset quality review. The European Banking Authority last month issued standards for defining nonperforming loans, aimed at stemming divergent practices across the euro zone. Banks could apply them as soon as the current quarter, according to senior executive at a major European bank—with the aim of getting their balance sheets in shape before the ECB’s inspectors come to town.

That could make the coming earnings season something of a bloodbath. Already, reserves against bad loans look short in some countries. Italian banks’ reserves covered only 41% of their bad loans at the end of September, according to Morgan Stanley. MS +0.06% If they were to raise that ratio to 65%, say, Italian banks would need an extra €11.3 billion of capital to meet a minimum core tier one equity ratio of 8%.

Banks in other countries have made progress earlier. Spain’s central bank this year forced its banks to clean up their mortgage lending books. That’s one reason why Spanish banks on average trade at close to their tangible book value, compared with Italian banks that trade at around 0.6 times tangible book, according to Berenberg Bank: Investors simply trust Spanish banks’ accounts more right now.

Bridging the credibility gap is becoming a matter of urgency for Europe’s banks.