Financial Services Foresight Risk and Regulation edition: EU banks and the stress test
The 2016 European stress test is currently being conducted, to assess how well the continent's largest banks would hold up in adverse economic circumstances. While the overall economy in Europe has continued to improve since the first such test was conducted in 2009, the recovery of the banking industry has been limited. Share prices of most of the continent's banks plunged early this year and if anything, uncertainty about the health of the financial sector is increasing. It's difficult to precisely predict the results, but our analysis suggests that altogether, the 51 banks participating in the test will have to raise up to €65 billion in new capital — significantly more than they did following the previous test, in 2014.
Sneak preview: European banks and the 2016 stress test
This estimate is derived from our analysis of what this year's test will measure. In light of the current state of Europe's economy and its banking sector, banking authorities have made several changes to the test's methodology this year. The evaluation will increasingly scrutinize areas such as net interest income, which is under heavy pressure in the current interest rate environment; vulnerability to volatility and overvaluation of assets by financial markets; how banks are running their business as gauged by the newly introduced conduct risk assessment; and continued dependence on capital elements that will be phased out in the coming years under the Basel Committee on Banking Supervision's accord, or Basel III.
Banks that are looking to increase their resilience to stress — although this year's test might come too soon — are well-advised to structurally improve profitability and restructure their balance sheets. This requires a fundamental assessment of their overall strategy in response to the current economic and regulatory environment, and a rethinking of their business models to prepare themselves for the long haul.
Which impact will the stress test have, how will it change the banking market? In our study we offer you a "sneak preview" on the overall stress test results. We hope you find this an interesting read — and stand ready should you wish to discuss our view on the stress testing implications and the banking market further.