Europe's banks have been told to put a figure on potential losses from holdings in Greek and other sovereign debt to ensure a health check of lenders realistically reflects the deepening euro zone crisis.
Sources involved in the European Union stress test of 91 banks said regulators are "tightening the thumb screws" on lenders to spell out the impact of a government debt default — but without having to make the politically unacceptable assumption in the test that a default can happen.
Until now fallout from the sovereign debt crisis was focused on a bank's day-to-day trading book but most government bonds are held on a bank's core banking book.
The disconnect has become even starker as sovereign woes get worse, giving regulators a bigger headache as they try to avoid another stress test flop."Banking books are being stressed much more harshly than last year and than in the original draft of this year's stress test. That will help increase the credibility of the tests," an official in charge of the stress test at his bank said. "That will result in factually putting countries like Greece on default status."
After last year's test flopped —Irish banks had to be bailed out after passing — the fledgling European Banking Authority (EBA) which is conducting the health check, is staking its reputation on delivering a credible exercise this time round.