By Huw Jones
LONDON (Reuters) - Europe's top banking regulator has set out rules to ensure EU banks cannot rely on national definitions to obscure the true state of their books in an upcoming assessment of whether they need more cash.
The last two rounds of the EU's "stress tests", which were widely criticized for not being tough enough, gave national authorities leeway to set key definitions such as what counted as a bad loan and which loans were subject to "forbearance".
This time around, with its credibility resting on the third attempt to convince investors banks have enough cash, top regulator the European Banking Authority (EBA) has prescribed newly-detailed rules to level the playing field.
The rules will be used by the European Central Bank (ECB) in its upcoming asset quality review (AQR) looking at whether the eurozone's top 130 banks such as Deutsche Bank (DBK.DE), Unicredit (UCG.MI) and BNP Paribas (BNP.PA) have properly faced up to the extent of their bad loans.
The 11 EU countries outside the eurozone must also carry out their own AQRs, which will also have to use the new rules.
The ECB will announce initial details of how its tests will be conducted at 0800 GMT on Wednesday.
"These recommendations promote consistency to the process and outcomes of the AQRs at the European level so that remaining doubts about the quality of assets across the EU may be alleviated," the watchdog said in a statement on Monday.
The bloc's financial services chief Michel Barnier said last week the results of the EU tests were not expected to be dramatic and that shortfalls of capital will most likely be plugged by tapping markets - rather than having to go cap in hand to taxpayers as during the 2007-09 financial crisis.
The EBA said all asset reviews across the EU should be completed by the end of October 2014. A separate bloc-wide stress test - to see if banks are prepared to deal with economic and financial shocks - will also be completed by October 2014.
A single set of bank-by-bank results showing any capital shortfalls will be published around October 2014. The EBA has yet to say what the "pass" threshold will be or how long lenders will have to plug any capital gaps.
The Authority's two previous stress tests failed to convince investors that lenders hold enough capital to withstand shocks unaided when the ECB money many of them hold is returned.
Its first rule set out on Monday relates to when a loan has gone sour - thus forcing the bank to set aside more capital - and replaces a patchwork of national definitions which have made it hard for investors to compare banks.
The EBA defines a loan as non-performing when a repayment is more than 90 days overdue or when repayment is unlikely.
A second rule defines when forbearance on a loan has taken place, meaning the bank has allowed the borrower to skip or reduce payments.
The watchdog said forborne loans can be identified in both non-performing and performing loans portfolios, meaning a forborn loan is not automatically deemed to be non-performing and thus trigger extra capital requirements.
The EBA will also publish by the end of this year updated figures on government debt holdings and types of capital held by the 90 or so banks it tested in the past.
(Additional reporting by Laura Noonan; Editing by David Holmes)