LONDON: The European Central Bank will consider the impact of future lawsuits and fines in its review of whether the eurozone`s 131 most important lenders have enough capital to withstand another recession.
The treatment of legal costs was outlined in a 72-page document detailing the quality assurance programme the ECB will use to assess the reams of data it has gathered about banks` portfolios, as well as the way this information will be fed into predictions of banks` future losses.
The highly-technical document was published on Friday as part of the ECB`s effort to ensure the tests are transparent and credible, crucial aspects if the ECBis to achieve its goal of removing investors` lingering doubts about eurozone banks before it becomestheir supervisor on Nov. 4.
`We are dedicating considerable time and effort to making this process rigorous,` said Vitor Constancio,vice presidentofthe ECB, adding that this distinguished its exercises from previous reviews by the European Banking Authority (EBA), which were widely discredited.
Eurozone banks have faced a raft of Knes for litigation since the ECB planned its review last year, most notably BNP Paribas` `s $9 billion June penalty to settle sanctions violations.
`Where the PP&A (processes, policies and accounting) review has highlighted any issues in relation to legal costs, the bank should have already been informed and instructed to take this into account in the projections of the stress test,` the ECBsaid in its stress tests manual.
This implies that banks at risk of litigation must make deductions from their future profits as they estimate how much cash they could burn over a threeyear horizon.
Banks that don`t make appropriate provision for this, or any other aspect of how their books would fare in a downturn, will have to amend their numbers if the ECB uncovers the shortcomings as part of its quality assurance process, the ECB said.
This process will look at whether future losses have been correctly calculated, and will compare loss rates across banks in different countries.
Banks whose loss expectations are found to be in line with the ECB`s models will get a `green flag`.-Reuters