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LONDON (Reuters) - An objective stress test of the euro zone's biggest banks could reveal a capital shortfall of more than 770 billion euros ($1 trillion) and trigger further public bailouts, a study by an advisor to the EU's financial risk watchdog and a Berlin academic has found.
The study and others published ahead of the EU stress tests, whose results are due in November, are important because they set the expectations against which markets will judge the credibility of the European Central Bank's attempt to prove its banks can withstand another crisis without taxpayer help.
If official figures are far below independent estimates, authorities will struggle to convince markets the tests are robust enough, particularly given two previous rounds of EU tests that failed to reassure markets of banks' health.
Banks have already raised over 500 billion euros from investors and taxpayers since the onset of the financial crisis, to bolster their balance sheets and help ward off a repeat of the 2008-09 financial crisis. But the sector is again on edge ahead of the stress tests, because of the risk that regulators will call for even greater buffers against another credit crunch.
The new study, by Viral Acharya, a New York University Professor and advisor to the European Systemic Risk Board (ESRB), and Sascha Steffen, of Berlin's European School of Management and Technology, was circulated to banks, think tanks and the ESRB in recent weeks.
In their paper, Acharya and Steffen said euro zone banks would need up to 767 billion euros to bring their capital to the level seen by the Bank of England's head of financial stability, Andrew Haldane, as needed for the banks to have withstood the last crisis.
The reference is to a 2012 speech where Haldane said the world's largest banks would have needed equity equal to 7 percent of their total assets to guard against failure in the financial crisis.
But the 767 billion euros figure only covers the 109 euro zone banks in the ECB's exercise who disclose detailed data about their finances, so the figure across the 128 banks being tested would be even higher.
Banks across the globe will have to meet a 3 percent ratio under the new Basel III regulation, but some national authorities are pushing for a higher threshold.
The European Central Bank (ECB) will complete its Comprehensive Assessment of the euro zone's 128 biggest banks by November 2014, in a bid to finally banish doubts about their balance sheets before Frankfurt becomes supervisor of banks including Deutsche Bank, Societe Generale (SOGN.PA) and Intesa Sanpaolo (ISP.MI).
The ECB's work will then feed into EU-wide stress tests on whether banks have enough set aside to weather future crises.
The authors' methodology is different from the EU and ECB tests, which interrogate the current financial positions of the banks and look at how much they would need to withstand specific future stresses, such as a fall in economic activity, a stock market crash or a global credit crunch.
"Balance sheets are not transparent enough for us to do what the ECB will do," Steffen told Reuters. But their independence could be an advantage.
"Objective capital shortfall estimates such as ours can provide a valuable defense mechanism against any ... political efforts to blunt the effectiveness of the proposed AQR (Asset Quality Review) and the intended recapitalisation of the euro area banking system," the paper said.
Acharya and Steffen, who singled out Belgium, Cyprus and France as countries whose banks could have significant shortfalls, along with Germany, also looked at how banks would be affected by a 40 percent fall in global stock markets over a six month period.
This analysis found the banks could need another 579 billion euros in a crisis to meet a 5.5 percent prudential capital ratio, a measure which adjusts for the riskiness of a bank's balance sheet and is marginally higher than the 5 percent used in the last EU tests in 2011.
A separate analysis assuming only that banks would have to write down non-performing loan portfolios suggested a capital shortfall of 232 billion euros, based on a "common equity Tier One" ratio of 8 percent, a benchmark of financial solvency.
The EU has not yet said what benchmark will be used, but reports this week said the ECB favoured a threshold of 6 percent.
That figure that would imply a lower capital requirement than the one assumed in the researchers' loan-loss forecasts.
The EU has agreed a 55 billion euros backstop to resolve failing banks, which will not be fully funded for another decade. The study said this would be insufficient to deal with fallout from the stress tests, as would other measures designed to ensure taxpayers aren't in the firing line once more.
"Our results suggest that with common equity issuance (e.g., through deep-discount rights issues) and haircuts on subordinated creditors (e.g, through bail-ins), it should be possible to deal with many banks' capital needs," they said.
"Some will, however, require public backstops, especially if bail-ins are difficult to implement without imposing losses on bondholders, who may themselves be other banks and systemically important financial institutions."
Editing by David Holmes