What you need to know about Europe’s bank stress tests

What you need to know about Europe's bank stress tests
AFP

Frankfurt am Main (AFP) – Europe’s top banking regulators published Friday the results of the latest stress tests on financial companies, giving an update on the vital sector’s health since the last round in 2016.

British and German banks suffered worst in a simulated economic downturn, the European Banking Authority (EBA) said, but highlighted that across the board lenders were better prepared for hard times than two years ago as tougher regulation has taken effect.

– Who was tested? –

Between January and October, the London-based EBA and the European Central Bank (ECB) put under the microscope a total of 48 lenders from 14 countries around the European Union and Norway.

Of those lenders, 37 are directly overseen by the ECB’s banking supervision arm, and between them account for some 70 percent of bank assets across the eurozone.

Among the sample are eight German banks, six French lenders and four each from Italy and the UK.

In May, the authorities published results for four Greek banks, offering a glimpse of their health before Athens emerged from its third EU bailout programme over the summer.

– How do the tests work? –

From a starting point of their financial positions at the end of 2017, the banks were confronted with a hypothetical scenario where the European Union’s gross domestic product (GDP) plunged by 2.7 percent between 2018 and 2020.

By the end of the period, that would leave the European economy 8.3 percent smaller than if it experienced steady growth.

On top of that, the tests simulated unemployment rising by 3.3 percentage points to levels last seen in 2009, during the financial crisis.

Meanwhile economic risks linked to Brexit like falling trade and financial market disruption were built in, as were falling property prices, losses on holdings of sovereign debt and even potential fines over embezzlement by managers.

The banks had it even tougher this time around compared with 2016, as new accounting rules mean they must update their balance sheets sooner to reflect potential losses on debt or other risky assets.

– What did the tests find? –

In the simulations, lenders’ capital ratio — which measures the buffers they have on hand to cushion financial turbulence — fell from a 2017 average of 14 percent to 10.1 percent in 2020.

2016’s testing round had showed a decline from 13.2 to 9.4 percent.

The EBA said that “banks’ efforts to build up their capital base in the recent years have contributed to strengthening their resilience and capacity” to withstand shocks.

British and German banks were among the worst performers this year.

Meanwhile Italian banks had been under intense scrutiny as a budget battle between Rome and Brussels has driven down the value of their government debt holdings.

But the tests found the Italian lenders matched or even outperformed their counterparts in Germany and the UK.

– What happens next? –

The authorities did not declare that any one bank has “passed” or “failed” their tests.

Instead, the individual impacts of the simulations on banks’ capital ratios “will serve as a diagnostic tool and could in some cases speed up corrective measures”, the German banking federation BdB said.

Supervisors will take into account a sharp fall in a lender’s capital ratio during the stress test when setting the amounts of additional capital they must have on hand on top of legal minimums.

For the ECB, the results will flow into a regular review of the banks it supervises, known as SREP, in January 2019.

It will issue recommendations for eurozone banks’ capital ratios, including a lower threshold that will trigger reduced dividend and bonus payouts if they fall below it.

“Looking ahead, the test helps us to see where individual banks are most vulnerable and where clusters of banks are most sensitive to certain risks,” ECB banking supervision chief Daniele Nouy said in a statement.

.

Please let us know if you're having issues with commenting.