European banks will be expected to prove they can survive a 7% drop in GDP
under new tougher stress tests unveiled by the regulator.
It says banks should also be able to withstand a 14% fall in house prices and
up to a 19% drop in share prices under a worst-case scenario.
The tests are designed to try and prevent further taxpayer bailouts.
The regulator said the tests would "address remaining vulnerabilities in the EU
banking sector".
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Analysis
image of Nigel Cassidy Nigel Cassidy Business correspondent, BBC News
Five months before the European Central Bank becomes the euro currency zone's
official bank watchdog, the pressure is ratcheting up on the 124 largest banks
to ferret out the worst of the non-performing loans and assets weighing down
their balance sheets.
A 7% fall in GDP might look less likely today - but Greece is still emerging
from a recession four times more severe than that.
Identifying financial holes on bank balance sheets in is one thing. But
plugging them is quite another now that the responsibility is being shifted
from governments to bank shareholders and bondholders.
The signs are that sometime soon, lenders in Germany and France may have to
join the likes of Italian, Spanish, Portuguese and Greek lenders in finding
more capital - principally by asking their investors to cough up for new
shares.
The main worry remains what the regulators will do with banks that are seen to
fail their tests but can't raise the cash.
By any measure, Europe's collective financial backstop is billions short of the
size needed to cope with a new wave of bank meltdowns.
"It will provide a common framework for the next stops to be taken by
supervisors and banks," said European Banking Authority (EBA) chair Andrea
Enria.
The tests are much tougher than the EBA's 2011 stress tests when it projected a
worst-case scenario of just a 0.5% fall in GDP.
At the time, the tests were widely criticised for being too soft, particularly
after 18 of the EU's 27 countries at that time had weaker growth than the
"adverse" case they were tested for.
"The key is that the scenario is at least as deep and dark as the great
recession, the financial crisis of 2008/2009," said Mark Zandi,
Philadelphia-based chief economist at Moody's Analytics.
Banks that fall short of capital under the EBA's worst-case imagined scenarios
will have to produce a plan to boost their reserves by raising fresh funds from
investors, selling assets or hanging on to profits instead of paying dividends.
European banks have already made several reforms, including raising billions of
capital ahead of the latest tests.
"What we're looking for is relevance of the scenarios, do they address what we
believe is the risk on the ground?" said Neil Williamson, head of EMEA credit
research at Aberdeen Asset Management.