Europe’s bank sector passes stress tests

Posted on July 29, 2016

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Italy’s Monte dei Paschi, the UK’s Royal Bank of Scotland, and Ireland’s Allied Irish Banks emerged as the biggest losers in the EU’s banking stress tests, which largely found that the region’s top 51 banks had enough capital to withstand another financial crisis.

While the tests abandoned their previous pass or fail marks, Italy’s embattled Monte dei Paschi was the clear failure — its key capital ratio turned negative by the end of the three-year adverse scenario of the test, indicating the bank would be insolvent.

    Immediately before the results were published, the bank said it would raise €5bn of capital and offload €9.2bn of bad loans. Earlier on Friday it rejected a rescue proposal from Corrado Passera, the veteran Italian executive and former minister, in partnership with Swiss bank UBS.

    As well as the worst end-point capital position, Monte dei Paschi had the biggest deterioration in its key capital ratio — known as its fully loaded common equity tier one (CET1) ratio, which takes into account new regulations due to come in soon.

    That ratio fell 14.51 percentage points for the stricken Italian bank — more than four times the average 340 basis-points deterioration — leaving MPS with a ratio of -2.44 per cent.

    The ratio across the sector was 9.20 per cent.

    Ireland’s AIB had the second biggest fall in its fully loaded CET1 ratio, losing 880 basis points to leave it a ratio of just 4.31 per cent. That makes the Irish government’s hopes of reprivatising the bank over the coming years more distant because the headline figure is likely to spook investors, even though it penalises the banks under some rules that will not come into effect until 2022.

    The UK is in a similar situation with RBS, which had the third biggest fall in CET1 ratio, losing 745 basis points to leave it at 8.08 per cent, still the 13th best in the group, which ended up with an average fully loaded CET1 ratio of 9.2 per cent at the end of the horizon. Barclays also emerged in a relatively weak position with a fully loaded CET1 ratio that fell from 11.4 per cent to 7.3 per cent in the adverse scenario.

    The overall results were less dramatic than those of the ECB’s inaugural analysis in 2014, which revalued the balance sheets of almost 130 banks and ordered the sector to raise €25bn. Those tests were widely discredited by the market as not harsh enough. The latest tests, while less closely watched by the market, are expected to face similar scrutiny.

    “Whilst we recognise the extensive capital raising done so far, this is not a clean bill of health,” Andrea Enria, chairman of the European Banking Authority said. “There remains work to do, which supervisors will undertake in the SREP [regulatory engagement] process.”

    Europe’s banks have raised €180bn since the end of 2013.

    This is not a clean bill of health. There remains work to do

    – Andrea Enria, EBA chairman

    The latest tests have already come in for criticism for not capturing shocks such as the UK’s unexpected decision to leave the EU, and negative interest rates. While they do include market shocks that are more severe than those seen in the immediate aftermath of the Brexit vote, the scenario does not capture the outsize risk for certain banks.

    The adverse scenario included falls in real EU gross domestic product of 1.2 per cent in 2016, 1.3 per cent in 2017 and 0.7 per cent in 2018 — a progression that is 7.1 per cent worse than the expected ‘baseline’ scenario.

    The stress tests also do not include the likely impact of some regulations that have not yet been finalised, known as ‘Basel IV’. KPMG said today that these would lead to an extra €350bn of capital requirements for 100 of the world’s biggest banks.

    Conduct risk — included for the first time after European banks paid out tens of billions in fines for past failings — cost €71bn over the three years in the adverse scenario. The EBA said that 15 banks estimated an individual conduct risk hit of more than €1bn.

    Credit risk losses in the stressed scenario from loans going bad had an overall €349bn impact on the banks. The EBA said loans to clients in Italy, the UK, Spain and France were the biggest contributors to the credit losses. Corporate exposures contributed €144bn of losses, while retail clients were responsible for €125bn of the losses.

    9.2%

    The banking sector’s CET1 ratio

    Market risk — including high-frequency trading and hedging — caused net losses of €8bn over the three-year stress exercise. But the impact against the gains that would otherwise have been generated was an overall €148bn.

    On a country-by-country basis, Ireland’s two tested banks averaged the lowest CET1 ratio on a fully loaded basis, with an average of 5.21 per cent. On a transitional basis, the Irish banks have a fully loaded ratio of 7.54 per cent, the second weakest in the group, after Austria’s 7.32 per cent.

    -2.44%

    Monte dei Paschi’s CET1 ratio

    Germany’s banking system also comes out relatively poorly. Four of the banks with the biggest deterioration in CET1 are in Germany, and Deutsche Bank and Commerzbank were both among the 10 banks with the lowest final CET1 ratios.

    In Italy, UniCredit had the sixth weakest CET1 on a fully loaded basis and the fourth weakest on a transition basis. The bank, which recently appointed a new chief executive, is widely expected to raise about €10bn of capital from rights issue and disposals. Intesa Sanpaolo, the other large listed Italian bank, fared relatively well, with an end-point fully loaded CET1 ratio of 10.21 per cent, above the average 9.2 per cent.

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