Europe’s stress tests: 5 things we know

Posted on July 29, 2016

A man walks on January 25, 2013 past the headquarters of the Banca Monte dei Paschi di Siena (MPS), the world's oldest bank to adopt a government aid plan amid revelations of a derivatives scandal. A media report on January 22 that said BMPS would book a 220 million euro ($293 million) loss on a three-year-old derivative contract was a heavy blow for the floundering bank, which is concluding a deal with the government for 3.9 billion euros in state aid. AFP PHOTO / FABIO MUZZI©AFP

Monte dei Paschi di Siena is Italy’s problem bank – it would be insolvent under the EBA’s adverse scenario

The European Banking Authority’s latest stress tests painted a broadly positive picture of the region’s 51 largest banks. But Andrea Enria, EBA chairman, was at pains to point out that not all was rosy. “This is not a clean bill of health. There remains work to do,” he said.

Here’s what the tests revealed.

Italy: problem bank

The board of Monte dei Paschi di Siena has approved recapitalisation of the Italian lender conditionally guaranteed by a pool of investment banks led by JPMorgan Chase as it seeks to stave off a bail-in under new European bank rules.

The rescue deal came just in time. Friday’s stress tests implied a huge capital shortfall at Italy’s third-largest lender, which was also the worst performer in the last stress tests of 2014. Monte dei Paschi ended the adverse scenario with a common equity tier one (CET1) ratio of -2.44 per cent, implying the bank would be insolvent.

The rescue — including a securitisation of its €50bn gross non-performing loan portfolio and a €5bn equity raising — is intended to put Monte dei Paschi’s long-running capital concerns behind it. Fabrizio Viola, chief executive, said: “The structure is a definitive solution to the bad loan legacy.”

Still, senior bankers and analysts remain cautious about the nature of its underwriting agreement. One analyst from Goldman Sachs repeatedly questioned Mr Viola about the conditionality of the underwriting.

UniCredit, Italy’s largest bank by assets, came out of the tests with a 7.1 per cent CET1 ratio under the adverse scenario — the sixth weakest overall.

Intesa Sanpaolo, Italy’s largest domestic lender and one of Europe’s most strongly capitalised banks, came out with a relatively healthy 10.2 per cent ratio.

Britain: bruised

File photo dated 03/12/09 of a woman walking past the headquarters of the Royal Bank of Scotland in the City of London as the bank was today hit by another embarrassing IT failure that left customers using its popular mobile app unable to access their accounts online. PRESS ASSOCIATION Photo. Issue date: Friday May 24, 2013. See PA story CITY RBS. Photo credit should read: Johnny Green/PA Wire©PA

UK banks were among the hardest hit in the tests. Royal Bank of Scotland had its fully loaded CET1 ratio reduced from 15.5 per cent to 8.1 per cent in the adverse scenario, the third-biggest fall of any bank.

However, no suggestion was made that any of the banks would be under immediate pressure to raise capital. Ewen Stevenson, RBS finance director, said the results “demonstrate our continued progress towards transforming the balance sheet to being safe and sustainable”.

RBS also finished above Barclays, which ended up with a 7.3 per cent ratio from a lower starting point. Barclays said it “remains comfortable with its target of building the ratio further” to keep a buffer of 100-150 basis points above the future regulatory capital requirements.

Lloyds Banking Group finished in the top third with a CET1 ratio of more than 10 per cent.

The Bank of England issued a statement welcoming the results, which it said showed that British banks could continue lending to the economy in a stressed scenario. It said the EBA exercise would be considered alongside the results of its own stress tests to be published later this year to assess capital adequacy of UK banks, but pointed sniffily to “methodological differences” between the two tests.

Ireland: not out of the woods

Ireland's Central Bank And Government Buildings...A European Union (EU) flag, top, fly's alongside the Irish national flag in Dublin, Ireland, on Tuesday, Nov.16, 2010. Ireland is in talks with European and International Monetary Fund officials about a bailout that would shore up the stateÍs finances as well as enable it to inject capital into the countryÍs banks, said a European official with direct knowledge of the talks. Photographer: Aidan Crawley/Bloomberg©Bloomberg

Seven years after their landmark bailout, Ireland’s big listed banks, Allied Irish Banks and Bank of Ireland, are still ranked among the weakest in Europe.

AIB came sixth worst of the 51 banks on a transitional capital basis, with a CET1 ratio of 7.39 per cent versus the average of 9.2 per cent. The bank, which the Irish government hopes to privatise in coming years, was second-worst on a fully loaded basis, which takes into account some regulatory changes that do not come into force until after the stress tests’ final point at the end of 2018. AIB’s fully loaded ratio fell to just 4.31 per cent by the end of 2018 under the adverse scenario.

BOI came in eighth worst on the transitional capital rules, with a CET1 ratio of 7.69 per cent and fourth worst on a fully loaded basis, with a CET1 ratio of 6.15 per cent.

A senior Irish banker said the results were “not realistic”, particularly for an economy such as Ireland’s, which is in recovery mode. “Any proper analyst will look at the methodology,” the banker said. He added that the banks had been treated as if they were continuing to own for the full three years some contingent convertible instruments that have already been repaid. This inlcudes €1.6bn repaid this week by AIB.

Germany: familiar problems return

The Deutsche Bank AG logo sits illuminated on the bank's headquarter offices at dusk in Frankfurt, Germany, on Wednesday, Jan. 27, 2016. Photographer: Krisztian Bocsi/Bloomberg©Bloomberg

Germany’s two largest lenders both scored worse than the eurozone average of 9.2 per cent. Commerzbank, the second-largest lender, would have just 7.4 per cent of CET1 ratio under the adverse scenario. Deutsche Bank would have 7.8 per cent, though its result was — surprisingly — better than Barclays, the UK lender which has a similar business model.

For the other seven lenders here the results were better. Nord LB, which has had difficulties with its portfolio of shipping loans, recorded a result of 8.6 per cent. BayernLB, another regional lender, was the only other German lender under the average, with a CET1 ratio of 8.3 per cent under the adverse scenario.

“Overall, the results are within the range of what was expected. Individually, the German banks did OK, but the tests showed that the sector still has its structural weaknesses,” said Martin Hellmich, professor at the Frankfurt School of Finance and Management.

“There are a lot of banks in Germany, which means that they have to fight very hard for market share in their core business areas, such as corporate and retail banking. This makes it hard for them to reach a decent level of profitability, which then makes it hard for them to build capital,” he said. He added that the tests had also highlighted the dependency of German banks on interest income.

Conduct: an expensive problem

€71bn

The figure added to cover the risk of misconduct in the stress test

Conduct risk was included in the stress tests for the first time, adding an extra €71bn over the three years in the adverse scenario. The EBA said that 15 banks estimated an individual conduct risk of above €1bn. In its statement, Deutsche Bank said the new conduct factor reduced its CET1 ratio by 220 basis points, implying that the hit to its fully loaded CET1 ratio would have been almost two-thirds smaller if not for litigation.

Laura Noonan and Martin Arnold in London, James Shotter and Claire Jones in Frankfurt and Rachel Sanderson in Milan

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