OREANDA-NEWS. The detailed results of the European Banking Authority's 2016 EU-wide bank stress test, to be published on 29 July, will highlight relative differences in resilience, says Fitch Ratings. The information on banks' base case and stressed capital ratios will be a valuable resource for investors and market participants.

We will focus on both the adverse result and on how much capital falls from the starting point in the adverse scenario. We expect the more highly rated banks to show greater resilience. But the degree of stress in the adverse scenario differs across EU countries (the real estate stress in Sweden, for example, is more severe than in other countries), and this needs to be understood when interpreting the results. Italian banks have the weakest average asset quality of the major European banks being tested and are therefore likely to be a key focus for investors.

Banks will report transitional and fully loaded common equity Tier 1 (CET1) ratios based on a static balance sheet with a 31 December 2015 reference date. Banks are not permitted to assume capital measures taken after the reference date, although it is likely that some will wish to highlight major 2016 developments in their accompanying disclosures and commentary. In practice, the static balance sheet means assets/liabilities that mature during the horizon are replaced on a like for like basis, and no workout of defaulted assets is assumed.

In the 2014 stress tests, banks that had agreed a restructuring plan with the European Commission were able to benefit from an exception to the static balance sheet constraint, which in some cases provided a significant benefit.

The number of banks tested in 2016 halved to 51 from 123 in 2014 due to the EBA's focus on a more homogenous sample of larger banks, although the authority says banks tested still represent around 70% of eurozone banking sector assets. Many of the banks included in the 2014 stress test but excluded this time are in southern Europe. The numbers for Spain and Italy have been reduced to six and five, respectively, from 15 in each country, and no Portuguese, Greek, Slovenian or Cypriot banks are included.

The results this time will inform the supervisory review and evaluation process rather than being subject to specific "fail or pass" capital benchmarks. In previous years, banks failed the test if they did not achieve a CET1 ratio of 8% in the baseline scenario and 5.5% under stressed conditions.

The 2016 exercise does not feature a parallel asset quality review, also unlike the 2014 stress test. This means haircuts and valuation adjustments will not be automatically applied to the financial data provided by the banks. The template data includes information on forborne and non-performing exposures and sovereign holdings, along with projections until end-2018.

A new feature of the 2016 stress is a mandatory assessment of the impact of potential future losses arising from conduct risk. In our view, assessing future conduct risk charges is tricky and will we be only in a position to assess the value of this disclosure once the test results are published. In addition, the 2016 stress test features several new constraints that increase the conservatism of the results, particularly for market risk and non-interest income and expenses.