Bank stress tests include two-year recession scenario

The stress tests to be carried out on Spanish banks from this month onwards as part of a pan-European examination of lenders will gauge their ability to withstand a scenario in which the economy contracts 1.0 percent this year and 1.1 percent the following year.

According to information released Friday by the European Banking Authority (EBA), the tests will also analyze the impact of a rise in unemployment to 22.4 percent in 2012 accompanied by deflation.

The government expects Spain's GDP to grow 1.3 percent this year before accelerating the following year. The economy contracted 0.1 percent last year. Spain's jobless rate currently stands at just over 20 percent.

The most negative scenario for Spain envisages a rise in the benchmark government bond yield of 165 basis points to 6.6 percent and a fall in the blue-chip Ibex 35 of 20.7 percent. It also includes a drop in house prices this year of 12.3 percent and 11 percent in 2012 and even sharper falls in other property assets.

The size of the fall in house prices is surpassed only by Ireland. Both countries suffered a property bubble that burst, driving down house prices.

The tests will be carried out between March and June, when the results will be published. They will cover 65 percent of the assets of the European financial system and at least 50 percent of the assets as of the end of last year of individual countries. However, 90 percent of the Spanish financial system will be subject to the examination, with only smaller lenders and credit cooperatives excluded. The EBA did not provide a list of the specific banks to be tested.

Five Spanish savings banks failed similar stress tests carried out last year. However, since then the process of consolidation in the sector has advanced, with a number of lenders tapping the Orderly Bank Restructuring Fund (FROB) to boost their capital.

The government has also increased the minimum core capital of commercial banks to 8 percent from 6 percent, and in the case of unlisted savings banks to 10 percent. Banks have until September to do so, although savings banks transforming themselves into commercial banks with a view to listing on the stock market have been given more leeway.

The EBA did not say what the minimum level of so-called Tier 1 capital required would be. The level in last year's tests was set at 6 percent of risk-weighted assets.

The tests will also attempt to gauge the impact of a sovereign debt crisis on the banks. Last year's examination was heavily criticized as less than rigorous. Irish banks passed the tests only to later require an injection of capital by the government, which caused a blowout in Ireland's public deficit and sparked the need for a bailout from the European Financial Stability Facility (EFSF) set up in the wake of the Greek debt crisis in May of last year.