“The stress tests have paved the way for the European Central Bank to assume full authority over the Continent’s banks. Like the Federal Reserve in the United States, it may choose to gradually stiffen the tests to increase the chances that they appear credible. One way to do that would be to determine whether the banks could meet a clearer measure of their capital called the leverage ratio. This yardstick, which is less vulnerable to manipulation, is included in American tests.
But applying the leverage ratio may reveal a yawning hole at European banks, according to an analysis by Sascha Steffen, an associate professor at ESMT European School of Management and Technology in Berlin, and Viral V. Acharya, a professor of economics at New York University. They first assumed European banks had to write off all the nonperforming loans that are not covered by reserves. Then they calculated how much equity capital the banks would then need so that their equity capital equaled 4 percent of total assets. In that situation, the banks in the sample would have a theoretical capital shortfall of nearly $350 billion.”