March 18 (Reuters) - Europe's regulators are still haggling over how tough to be on capital requirements for banks undergoing more stress tests after last year's flopped.
Investors hope a second round of stress tests already underway will clear up worries about which lenders have sufficiently robust capital to withstand economic shocks.
But the region's new banking watchdog said on Friday that a stricter capital definition it hoped would make this year's exercise more credible had still not been agreed, preventing it from setting a pass or fail mark.
Here are the details of the methodology behind the stress test, provided by the European Banking Authority on Friday.
For a Take A Look on stories and graphics on the European stress test click on:
MACRO ECONOMIC ASSUMPTIONS:
The EBA says the adverse scenario used for its test is more severe than last year on a number of criteria. Its baseline assumption is the autumn 2010 European Commission's forecast.
The stress test assumes a 4 percentage point drop in GDP from the baseline assumption over 2011 and 2012. That would see a 0.4 percent contraction in 2011 and flat growth in 2012 across the region. That includes a 4 percent contraction in Greece and a 3 percent drop in Portugal this year, and a 1.1 percent contraction in Spain each year.
Unemployment across the EU would rise to 10 percent in 2011 and 10.5 percent in 2012, including a rise next year to 22.4 percent in Spain and near 16 percent in Ireland and Greece.
EU inflation is assumed to be 0.1 percent lower than the official forecast in 2011 and 0.5 percent in 2012.
House prices in EU countries are assumed to drop by 3.8 percent this year and 11.6 percent next year across the EU, with falls seen in most markets. UK house prices are seen dropping near 25 percent over the two years.
Yields on bonds are affected by sovereign strains, with long-term interest rates assumed to rise by 66 basis points on average across the EU.
Stock market prices are assumed to fall by 14 percent across the EU.
CAPITAL ALLOWED/PASS MARK:
The capital threshold will be focused on a definition of core Tier 1 capital, which is more restrictive than the Tier 1 definition used last year. The EBA is defining common criteria for core Tier 1 capital that will be applied consistently.
The pass rate cannot be set until that is defined.
The EBA said it could release both in about a week.
SOVEREIGN DEBT SHOCK:
The test assumes a fall in the price of government bonds, which will be applied to assets in trading books. These "haircuts" will apply to their fair value at the end of 2010.
The haircut for 10-year sovereign bonds is 19.8 percent for Portugal, 14.6 percent for Spain, 13.1 percent for Italy and 3.5 percent for Germany.
Banking book assets, which are regarded as longer term holdings, will not be subject to haircuts. Banks will be required to provide sovereign debt exposures by portfolio, country and maturity.
The test includes some strain on banks' funding costs due to the sovereign stress.
RAISING CAPITAL:
Each country should have a backstop plan in place before the results come out to recapitalise banks that fail.
Failing banks will be given a deadline to recapitalise.
Some regulators may require banks that scrape a pass to recapitalise too. This could include raising funds with other instruments, such as contingent capital, for example.
The test will be conducted on the assumption of a static balance sheet and banks maintaining the same business mix.
Revenue and cost assumptions for the banks should be in line with zero growth, after last year's test was criticised for allowing banks to assume too much in retained earnings.
The test will assume no mitigating action, such as selling assets in trouble.
BANKS TESTED:
The EBA has not named the banks to be tested. It is expected to be about 88 lenders, compared to 91 last year, representing over 60 percent of EU banking assets.
Liquidity risk is being assessed in a separate review, which will not be released.
Only regulatory changes that come into force before the end of 2012 are included in the test.
TIMELINE:
Late-April: Data should be provided to the EBA
May: Peer review and quality assurance process
Early June: Prelimary results
Late June: Publication of results expected
(Compiled by Steve Slater and Huw Jones)