European Union banks will have to show they can withstand a 7 percent fall in GDP under new and tougher stress tests set out by the European Banking Authority.
The guidelines issued Tuesday also stipulate that banks should show they can weather a 14 percent drop in housing prices and a 19 percent drop in share prices under a worst-case scenario. The EBA is issuing these tests to keep banks in check and to prevent financial collapses that result in taxpayer bailouts.
"It will provide a common framework for the next stops to be taken by supervisors and banks," said European Banking Authority chair Andrea Enria.
The guidelines come five months before the European Central Bank becomes the EU's official banking regulator. The central bank is attempting to get banks to clean out the worst of their non-performing loans and assets, which could be weighing down their balance sheets.
The tests are tougher than those issued in 2011, in which the EBA projected a worst-case scenario of a 0.5 percent drop in GDP. The tests were criticized for being too soft, considering 18 of the 27 EU countries at the time had weaker growth than the "adverse" case they were tested for.
Banks that fail to meet the capital requirements will have to submit plans on how they plan to raise capital -- from investors, by selling assets or hanging onto profits instead of paying dividends.