Five Irish banks are included in the European Central Bank's preliminary list of 124 lenders that will be subject to its comprehensive assessment of supervised banks next year.

The Irish banks are Bank of Ireland, AIB, Ulster Bank Ireland, Permanent TSB and Merrill Lynch International Bank.

The European Central Bank today vowed to submit the euro zone's top banks to a comprehensive batch of tests next year, staking its credibility on a review that aims to build confidence in the sector.

The ECB wants to unearth potential risks hidden in banks' balance sheets before supervision is centralised under its roof from November 2014 as part of a European banking union.

That broader plan was drawn up in response to the euro zone debt crisis that undermined economies around the world and was made worse by banking black holes in several countries.

Merril Lynch in Ireland

Four of the five names on the Irish bank test list are well known retail banks - Bank of Ireland, AIB, Ulster Bank Ireland, Permanent TSB. But the fifth name - Merril Lynch International Bank Ltd - is less well known.

Merril Lynch International Bank is a subsidiary of Bank of America/Merril Lynch, which was formed by the takeover of Merril by BofA in September 2008.

Based in Leopardstown, Dublin 18, it declared a loss in 2012 of $729m (€528).  Its balance sheet was $490bn (€355m).

Its 2012 annual report says: "The Group is a banking entity and has its head office in Ireland with branch offices in Amsterdam, Bahrain, Frankfurt, London, Madrid, Milan, Rome, Singapore, Toronto and Paris.

The Group acts as a principal for debt derivative and foreign exchange transactions and engages in advisory, lending, loan trading and institutional sales activity. The Group also provides collateralised lending, letters of credit, guarantees and foreign exchange services to, and accepts deposits from, its clients.

The Group provides mortgage lending, administration and servicing in the UK non-conforming residential mortgage market.

The Group's activities are regulated by the Central Bank of Ireland."

However the Central Bank of Ireland points out that Merril Lynch International Bank's home country regulator is in the US, where its parent company (BofAML) is based. 

It is the same with Ulster Bank, which is a subsidiary of British regulated bank RBS. 

It has been the British taxpayer who has been paying for Ulster Bank's losses in Ireland, and it would be expected that were MLIB to run into difficulties, the Irish taxpayer would not be on the hook.

Tough new measures for ECB

Setting out its plans to scrutinise the top euro zone banks, the ECB said it would use tougher new measures set out by Europe's top regulator - the European Banking Authority - in the asset quality review it will conduct next year.

"A single comprehensive assessment, uniformly applied to all significant banks, accounting for about 85% of the euro area banking system, is an important step forward for Europe and for the future of the euro area economy," ECB President Mario Draghi

"Transparency will be its primary objective," he said. "We expect that this assessment will strengthen private sector confidence in the soundness of euro area banks and in the quality of their balance sheets."

The ECB said it would conclude its assessment in October 2014, before assuming its new supervisory tasks in November although some policymakers have suggested that timing could slip. 

If capital shortfalls are identified, banks will be required to make up for them, the ECB said. Draghi has said a "public backstop" must also be available.

Detailing the measures it will use in its review, the ECB said it would use the EBA's definition of non-performing loans. The EBA said this week it will define bank loans more than 90 days overdue as non-performing. 

The ECB also said it will ask banks in its balance sheet review for an 8% capital buffer. The buffer could have been higher but may still prove a challenge to some banks as they reshuffle their balance sheets to make them crisis-proof.

The ECB wants a tough review so that it does not face surprises once it has taken charge, and to avoid repeating the mistakes of two earlier European-wide stress tests that failed to spot risks that led to the Irish and Spanish banking crises.

The ECB's new supervision role is the first leg of a three-pronged plan for a banking union in the euro zone, to further integrate the bloc's 17 economies.

Wary of a lopsided banking union that could see it supervise euro zone banks without a common backstop in place, the ECB has urged governments to agree on a strong single resolution mechanism (SRM) to salvage or wind down banks in trouble.

However, this second stage of the planned union is incomplete as politicians discuss how much of the costs should be shouldered by taxpayers. Plans for a third stage, a common insurance scheme, have stalled.

"For the success of the exercise, the ex ante availability of backstops is critical," the ECB said, adding that capital shortfalls should be first and foremost made up with private sources of capital.

Some ECB policymakers feel uncomfortable taking on the extra responsibility and have suggested spinning off bank supervision into a separate institution over the long term. But such a step would require a change of the EU treaty, which might take years.

A Morgan Stanley survey of investors this month showed between five and 10 of the banks to be tested by the ECB are expected to fail the tests and could be forced to raise up to €50 billion to bolster their capital.

However, some banks may be unable to raise capital on their own and the euro zone crisis has shown that sometimes even national governments can not afford to stage rescues. Spain - the euro zone's fourth biggest economy - had to take international help to tackle its banking problems. 

Key details of the ECB's plan

CAPITAL BENCHMARK - Banks will need to hold 8% of common equity Tier 1 capital as a minimum, using the Basel III definition but including transitional arrangements. The benchmark will consist of a common equity Tier 1 ratio of 4.5%, a 2.5% capital conservation buffer, and a 1% add-on to take into account the systemic significance of the banks. The ECB said the median core Tier 1 capital ratio for the largest euro area banks is about 12%.

BANKS - The ECB said about 130 banks in the 18 member states will take part in the test, accounting for 85% of the euro area banking system. A provisional list of banks includes 24 German banks, 16 in Spain, 15 in Italy, 13 in France, seven in the Netherlands, five in Ireland and four each in Greece, Cyprus and Portugal.

TIMING - The assessment will start in November 2013 and finish in October 2014, just prior to the ECB assuming its supervisory role. The ECB will release results in a single disclosure. The ECB will design the assessment and monitor it, and national regulators will execute it in each country. Consultancy Oliver Wyman will be the main advisor, and each country will use other private sector advisors.

AIMS - The ECB said there are three main goals:

1: Transparency - to enhance the quality of information available on the condition of banks;

2: Repair - to identify and implement necessary corrective actions. That can include increasing provisions banks have for assets and forcing them to recapitalise, retain profits, issue equity, change their funding mix or sell or separate assets. Capital shortfalls should come from private sources, but if that is insufficient public backstops might be needed, and should be established before the completion of the exercise;

3: Confidence building - to assure all stakeholders that banks are fundamentally sound and trustworthy.

PROCESS - It will be a three step process:

1. A supervisory risk assessment to review risks, including liquidity, leverage and funding;

2. An asset quality review (AQR) to assess the quality of banks’ assets, including asset and collateral valuation and any provision, based on balance sheets at the end of 2013. It will cover sovereign and institutional holdings and corporate and retail exposures, and both the banking and trading books will be reviewed;

3. A stress test to examine the resilience of banks’ balance sheet to stress scenarios, carried out in conjunction with the European Banking Authority.

The ECB said more details will be released in due course.