OREANDA-NEWS. July 27, 2015. A total of EUR25bn of new capital earmarked for the Greek banking sector in the Euro Summit Statement of 12 July should be sufficient unless deferred tax assets (DTA) cease to be counted as core capital, says Fitch Ratings in a report published today.

Aggregate deferred tax credit-eligible DTAs of Greece's four largest banks, which jointly have a 96% market share, represented 45% of their joint common equity tier 1 (CET1) as of end-2014. While our base case is that the existing, favourable regulatory treatment of DTAs will continue as banks calculate mandatory minimum Pillar 1 capital, there is considerable uncertainty and there is scope within the Pillar 2 supervisory framework, which provides regulators with additional tools to assess the adequacy of bank capital, to adopt a harsher approach.

Fitch's own core capital measure deducts DTAs relating to losses carried forward that rely on future profits. In comparison, convertible DTAs should have greater loss absorbing capacity, but they are untested and depend in part upon the credit standing of the government.

The inflow of up to EUR25bn of new capital is significant - almost 88% of current equity in the system - but whether this will be enough depends, in part, on whether the banks' existing capital can absorb the potentially significant losses likely to be uncovered once the ECB completes a review of the country's largest banks after the summer.

We analysed two stress scenarios. The first assumes a rise in impaired loans of EUR25bn to capture the European Banking Authority's (EBA) wider definition of non-performing exposures (NPE), which is tougher than the commonly used impaired loans figure, a rise in loan loss reserve cover to 60% from 50%, a 20% valuation adjustment on Greek government securities held by the banks and a target CET1 ratio of 12%. Under this scenario, we estimate that banks would require EUR11.2bn of new capital.

The second, more severe, scenario brings Greek banks' impaired loans in line with NPE and performing forborne exposures reported by Cypriot banks as of April 2015. We estimate a capital shortfall of around EUR15.9bn under this scenario.

Scenario outcomes are highly sensitive to a wide range of assumptions, the most significant of which is the treatment of DTAs. If these are not given full equity credit, the current EUR25bn earmarked for the Greek banks could, under our scenarios, fall short of the aggregate capital needs to all four banks to restore their CET1 ratios up to 12%, with estimated capital needs under the first scenario of up to around EUR30bn and up to EUR37bn under the second scenario.

The Chair of the Single Supervisory Mechanism, Daniele Nouy, has frequently raised concerns over the extent to which national discretion allows heavy reliance on DTAs and it is uncertain whether the ECB will continue to permit their inclusion in regulatory capital in its current form over the long term.

The report, entitled 'Recapitalising Greek Banks: Sufficiency of EUR25bn Recapitalisation Package Depends on DTA Treatment' is available at www.fitchratings.com