EU to include liquidity in bank stress tests

European Union finance ministers agreed on Tuesday to include targets on liquidity in new, tougher European bank stress tests, but bankers remain sceptical whether tests will placate nervous investors.

The tests will encompass the same 91 banks as were tested in 2010 but the methodology will be more stringent, including not only bank trading books, but also banking books and tough tests of core tier 1 capital, EU presidency sources said.

The credibility of a previous round of stress tests was undermined by the failure of a raft of Irish banks shortly after they passed a Europe-wide health check.

Mounting loan losses and funding difficulties in the banking sector eventually forced the Irish government to seek an 85 billion euro ($114.3 billion) EU/IMF bailout.

EU leaders agreed on a new review of the region's banks late last year as part of efforts to win back confidence of financial markets.

"The message is that the tests have to be much more stringent and credible," one EU presidency source said.

The exact criteria of the tests will be worked out by March.

But observers remained sceptical about whether the tests will reflect the true financial health of Europe's lenders.

"The tests will be tailored to achieve the results regulators want to see," said a senior investment banker specialised in banking transactions, who declined to be named.

Test results that show European lenders to be in very bad health could cause a freeze of the inter-bank lending market, exacerbating the financial crisis regulators are struggling to contain, he added.

The European Central Bank, which will play a key role in designing the tests, expects more banks to fail them than the five that did so last year because of the liquidity criterion, EU sources said, but did not indicate how many.

EU sources also said that in parallel to the EU tests, the International Monetary Fund would conduct a similar exercise in Britain, Sweden and Luxembourg.