- Here is an in-depth look at the recent stress test conducted by the European Banking Authority (EBA) and its impact on the European banking sector.
In a recent stress test conducted by the EBA, the resilience of the European Union’s banking sector was put to the ultimate challenge. The trial, designed to ensure that banks can withstand severe economic shocks, revealed that three banks from the EU failed to meet the binding capital requirements. The fallout resulted in a theoretical loss of a staggering $546 billion (496 billion euros) from their capital buffers. Today, we delve into the key findings of the stress test and its implications for the region’s financial stability.
Stress Checks – Post-2008 Financial Crisis
After the global financial crisis of 2008, bank stress tests became a crucial feature of financial regulation in both Europe and the US. The problem exposed the vulnerabilities of under-capitalized banks, leading to taxpayer-funded bailouts. Since then, stress tests have been a routine supervisory measure to ensure that banks can support the economy even during periods of market turmoil.
Scope of Stress Test
The recent stress test conducted by the EBA examined 70 banks, including 57 from the euro-zone, overseen by the European Central Bank (ECB). These 57 banks represent about 75% of banking assets in the EU, making the exercise comprehensive and significant. The scenario assumed a three-year outlook until 2025, considering credit, market, and operational risk losses.
Among the banks tested, German lenders garnered attention, with 8 out of 14 falling below the EU average for CET1 and leverage ratio. Notably, the banks that performed better were primarily subsidiaries of US banking giants like Goldman and JP Morgan, or financing arms of companies such as Volkswagen Bank.
How Rigid Is the Test
The EBA described this stress test as its most rigorous yet. It incorporated a grim scenario with a cumulative 6% economic growth slump and significant declines in property prices over the three years. Despite the challenges, the banks’ average capital buffers were reduced by 459 basis points to 10.4%, a relatively minor decline compared to previous tests.
Corrective Measures
While there is no pass or fail mark in the stress test, the results help supervisors assess whether banks need to hold extra capital in addition to their mandatory core buffer. The European Banking Federation (EBF) expressed confidence in the sector’s resilience, with almost all banks meeting their mandatory capital requirements.
However, the test revealed that four banks did not meet their mandatory leverage ratio requirements, emphasizing the need for additional capital safeguards. Moreover, 37 banks fell below the capital levels that trigger curbs on payouts, indicating that they may need to reevaluate their dividend and bonus distribution policies.
Credibility of Tests
Not everyone is satisfied with the stress test results. Deutsche Kreditwirtschaft, an umbrella association representing the German financial industry, lauded the resilience of German banks but criticized the European Central Bank’s approach. It suggested that the ECB’s markups during the test process led to increased stress-related capital losses, undermining market participants’ confidence.
In the end, while most banks demonstrated resilience, the stress test also revealed areas that require further attention and capital reinforcements. These tests continue to be a valuable tool in safeguarding the stability of the EU’s financial system, providing essential insights into the robustness of its banks.
