EU stress test: Most banks have enough capital to deal with a crisis

The European Banking Authority (EBA) released the results of the stress test of 51 banks of the European Union. The test had no pass/fails situation and shows how bank’s capital would respond to adverse scenarios. The banks that had the worst results were Monte dei Paschi (Italy) Raiffeisen (Austria), Banco Popular (Spain) and two Ireland's main banks (Allied Irish Bank and Bank of Ireland).

Italy's Monte dei Paschi was the worst performer. According to the test 14% of its capital would be wiped out under an adverse scenario. Earlier the bank announced a rescue plan that included the sale of bad loans and a capital injection.

In the adverse scenario, tier one capital of the worst banks would drop to -2.44%/Monte Paschi, 4.31%/Allied Irish, 6.62%/Banco Popular and 6.15%/Bank of Ireland.

“Whilst we recognize the extensive capital raising done so far, this is not a clean bill of health. There remains work to do”, said EBA Chairman Andrea Enria in a statement.

Key Quotes:

“The EU banking sector has significant shored up its capital base in recent years leading to a starting point capital position for the stress test sample of 13.2 % CET1 ratio at the end 2015. This is 200 bps higher than the sample in 2014 and 400 bps higher than in 2011.  The hypothetical scenario leads to a stressed impact of 380 bps on the CET1 capital ratio, bringing it across the sample to 9.4% at the end of 2018.  The CET1 fully loaded ratio falls from 12.6% to 9.2%, while the aggregate leverage ratio decreases from 5.2% to 4.2% in the adverse scenario.”

“The 2016 EU-wide stress test does not contain a pass fail threshold. Instead it is designed to support ongoing supervisory efforts to maintain the process of repair of the EU banking sector.”

“The adverse scenario implies EU real GDP growth rates over the three years of the exercise of  ‐1.2%,  ‐1.3% and 0.7% respectively – a deviation of 7.1% from its baseline level in 2018. It assesses 51 banks from 15 EU and EEA countries – 37 from SSM countries and 14 from Denmark, Hungary, Norway, Poland, Sweden and the UK.”

“The impact of the adverse scenario demonstrates the value of this capital strengthening as the weighted average CET1 capital ratio falls by ‐380bps2 bringing the ratio across the sample to 9.4% at the end of 2018. This fall in the capital ratio is mostly driven by a capital depletion of €269bn although REAs also increase by 10%. The impact on a fully loaded basis is lower at ‐340bps (from 12.6% in 2015 to 9.2% in 2018). The impact varies significantly across banks with 14 institutions projecting an impact of more than ‐500bps on a transitional basis. One bank reports a reduction in the CET1 ratio of more than 14 percentage points. The aggregate leverage ratio decreases from 5.2% to 4.2% in the adverse scenario.”

“The impact is mostly driven by credit risk losses of €‐349bn contributing ‐370bps to the impact on the CET1 capital ratio. The remaining losses are due to operational risk including conduct losses (€‐105bn or  ‐110bps) and market risk across all portfolios including CCR (€‐98bn or  ‐100bps). Although losses are partly offset by income, this is also stressed, for example NII decreases significantly in the adverse scenario (‐20% relative to the starting point) highlighting strains in profitability. In turn this results in a net total cumulative loss of €‐90bn over the three years (‐100bps) – excluding €91bn (100bps) of market risk losses directly recognised in capital. The remaining capital depletion is mostly due to dividends paid and transitional arrangements.”

“The outcome demonstrates resilience in the EU banking sector as a whole thanks to significant capital raising. The results for individual banks vary significantly and will inform supervisory discussions in the SREP to understand each banks’ resilience to shocks, after taking into account their specific circumstances and credible management actions.”

Bank of England: UK banks have resilience

Four UK banks participated in the EBA test (Barclays, HSBC Holdings, Lloyds Banking Group and The Royal Bank of Scotland Group). According to the Bank of England “the results for the four banks are consistent with those of previous Bank of England stress tests. They provide evidence that major UK banks have the resilience necessary to maintain lending to the real economy, even in a macroeconomic stress scenario.”