* ECB releases 285-page manual for asset quality review
* On avg 1,250 loan files per bank to be checked by Aug
* Common guidelines for asset valuation, loan impairment
* Banks may be asked to change internal models, policies
* Collateral values updated if over 1 year out of date
By Eva Taylor
FRANKFURT, March 11 (Reuters) - The European Central Bank(ECB) will press banks to revalue their assets and take a morerealistic view on likely losses when it probes their balancesheets in coming months, signalling a new, more aggressive eraof banking supervision in the bloc.
Publishing guidelines on Tuesday for its forthcoming assetquality review (AQR), the ECB said it would trawl throughtrillions of euros of assets at 128 leading banks between nowand August, aiming to ferret out any problems before it takesover as the euro zone's banking watchdog in November.
The exercise is part of a bigger plan to harmonise the waybanks are supervised and if necessary wound down, aiming torestore the sector's stability and avert a repeat of the debtcrisis which cost trillions in taxpayer bailouts.
While preparations for coordinated supervision are alreadyin full swing, European ministers were still trying to agree onhow to build a safety net for failing banks on Tuesday inBrussels, redoubling efforts to avoid an embarrassing delay tothe euro zone's centrepiece crisis reform.
Sabine Lautenschlaeger, vice chair of the banking watchdogand a member of the ECB's executive board, told the Wall StreetJournal she expected some banks would need to improve theircapital situation as a result of the tests, either by raisingfunds or selling assets, without giving a specific number. "It'sthe last chance to clean up," she was quoted saying.
The asset quality review will be followed by "stress tests"to see how banks would fare under certain shock scenarios. Allresults will be released in October.
Estimates of banks' capital shortfall range from 280 billioneuros ($388.6 billion) to as much as 770 billion.
Previous stress tests of leading EU banks failed tocompletely root out problems in the sector and the scope of thecurrent review that combines backward looking checks and forwardlooking stress scenarios is unprecedented.
Euro zone banks have never before been measured againstcommon thresholds, such as a single definition of when loansbecome impaired, and many have never had their booksinterrogated in such detail. Previous tests relied on locallyapproved data.
"We expect the AQR and stress test to introduce greatertransparency on 'problem assets' and speed up the healingprocess," said analysts at Citi.
Many banks have already been raising funds, shedding assetsand writing off bad debts ahead of the review and stress tests.Italy's Unicredit (Berlin: CRIH.BE - news) for instance on Tuesday posted ashock 14 billion euro loss after writedowns on goodwill and badloans, as it moved to clean up its balance sheet ahead of theECB's health check.
Once the results are known, the ECB will push banks toreflect some of the findings in their 2014 accounts.
Banks will only be expected to change their 2013 accounts inthe unlikely event that the review highlights issues that shouldlead to a restatement according to local law, it said.
The ECB's guidelines also set out different scenarios whenloans should be classified as impaired. For example when adebtor has requested emergency funding from a bank, or if acompany that has taken a loan gets into financial difficulty andexperiences a material decrease in turnover or the loss of amajor customer.
As part of the exercise, the teams will also check whethercollateral, for example in the form of real estate, aircraft,ships or artwork, is correctly valued, with help from externalexperts or by updating recent independent market valuations.
Collateral that has not been valued in the previous 12months will have to be re-evaluated.
Collateral valuations are one of the biggest sources ofuncertainty for banks in Italy. Sources told Reuters on Fridaythat the Bank of Italy was hiring up to five real estateconsultants to assess whether banks are correctly valuingproperty used as loan collateral.
Beyond loans, "level 3 assets" - a broad group of assetsthat are difficult to value - will also be assessed. Theseinclude derivatives, assets such as real estate holdings whichbanks have acquired through foreclosures, participation inprivate equity deals and special investment vehicles.
The ECB will run a more in-depth review of such assets at 29banks with material exposures, which include Deutsche Bank (Xetra: DBK.DE - news) , Commerzbank (Xetra: CBK100 - news) , Societe Generale (Paris: FR0000130809 - news) ,UniCredit and Santander.
"It is expected that, in most cases, fewer than 10derivative pricing models will be reviewed for each bankincluded in the trading book review, depending on the size ofthe bank's exposure to level 3 derivatives," the manual said.
Some banks included in the trading book review will have norelevant level 3 derivative pricing models to review, it added.