Europe to mark down Greek debt in bank tests

Stress tests on European banks need to mark down the value of Greek government debt by about 16 percent, sources said, as regulators haggled over how much detail to reveal about the health checks.

The Committee of European Banking Supervisors (CEBS), which is overseeing the tests on behalf of the European Central Bank (ECB), was expected on Wednesday to outline its methodology for a stress test that simulates the impact of a severe economic shock on about 100 banks in the euro zone and other countries.

But that could be delayed by discussions about the scope of the test and the detail to be released when the results are due around July 23, people involved in the process said. The statement could be delayed until Thursday.

The unusual move to disclose the test's design ahead of the results would mimic the procedure of last year's U.S. stress test, which was widely credited with reviving trust in banks.

Whether to apply a haircut on the value of debt in countries including Greece, Portugal and Spain is one of the key issues facing European regulators keen to show the tests are stringent and realistic.

There is a confidence deficit in the ability of the Europeans to execute these complex financial stability exercises, said Carlos Egea, credit strategist at Morgan Stanley.

Two German banking sources said a haircut of 16 to 17 percent off the market price would be applied to Greek debt. Greece's 10-year bonds are trading at about 75 percent of their par value at present.

No haircut would be applied to German sovereign bonds, the sources said, and a 0.7 percent markdown would be applied to French sovereign bonds, one of the sources said.

Sovereign bonds of Portugal, Spain, Italy and Ireland would see more significant markdowns, the sources said.

A 3 percent loss will be applied to Spanish bonds, Bloomberg reported.

The scenario used in the stress test on banks' ability to withstand an economic downturn will assume different rates of decline in gross domestic product (GDP) in 2010 and 2011 for different countries, the sources said.

For Germany, for example, the test will assume 2010 GDP growth of 0.2 percent and a small decline in 2011.

The last-minute haggling between 19 countries involved in the test over whether and how to make the design available, however, highlights fractious European Union decision making and contrasts with U.S. military-style crisis management.

TRANSPARENCY KEY

Failure to come up with a stress test that meets market expectations for transparency and for a plan on how to deal with problems it reveals may even backfire.

The lack of a powerful executive and the dominance of national governments with domestic agendas was also blamed for the European Union's slow and inconclusive reaction to the Greek debt crisis, which in turn revived doubts about its banks.

EU policymakers decided last month to break with tradition and publish the stress test results bank-by-bank and for a much bigger group of lenders than planned, hoping they can reproduce the effect the U.S. tests had.

Markets are so far unconvinced the tests will live up to the U.S. example, which was seen to provide clarity about the banks' doubtful assets and a strict regime for how to handle problems.

Bankers involved in the stress tests said questionnaires for the test with detailed economic assumptions were sent out on Monday and had to be returned by July 15 to national regulators, which would review and may revise the banks' own assessments.

Investors attention will not only focus on the scenario itself, however.

Providing more detail about problematic assets, including bonds issued by peripheral euro zone countries and loan exposures to troubled pockets such as Spanish real estate or small and medium companies, was one of the main hopes investors have for the stress tests.

Transparency is even more important than the scenario that is applied, said Morgan Stanley's Egea. The end result needs to be that the market really understands how much risk the banking system is carrying.

SPAIN PUSHING, GERMANY PUSHING BACK

Doubts about European banks' ability to clean up their balance sheets have limited their ability to raise funding on the market and made them highly dependent on the massive liquidity taps the ECB opened after Lehman Brothers' collapse in 2008.

The initial push for the publication of stress test results came from the Bank of Spain which said it wanted to show its banking system was stable and any shortfalls could be addressed.

Germany in particular pushed back on several counts, sources close to the process have said, including the suggestion that the publication should only say which banks passed and which failed, without further detail.

The test is expected to cover banks in the 16-nation euro currency area as well as Britain, Sweden and Denmark. Banks tested include BNP Paribas, HSBC, Deutsche Bank, Santander and UniCredit, but also regional German landesbanks and Spanish cajas.

(Additional reporting by Alexander Huebner, Angelika Gruber and Philipp Halstrick in Frankfurt, Boris Groendahl in Vienna, Huw Jones in London and Mia Shanley in Stockholm, writing by Boris Groendahl and Steve Slater; Editing by David Cowell and Erica Billingham)