Comprehensive balance sheet assessment by the European Central Bank (ECB) reveals a capital impact of 9.5 bn Euro for 130 participating banks

25 fail the test, and pressure on the business model continues for many banks

London, October 27, 2014 — The long-awaited results of the Comprehensive Assessments by the European Central Bank (ECB) of 130 system-relevant banks in the Eurozone have been published. Banks were subjected to an Asset Quality Review (AQR) and, combined with another 20 banks from non-Euro countries, to a stress test in collaboration with the European Banking Authority (EBA).

13 banks failed the test and a further twelve banks only passed because they addressed a capital deficit via capital measures in the first nine months of 2014. The ECB identified a capital shortfall across these banks of 25 bn Euro of which 9.5 bn Euro still need to be raised. When further subtracting the already announce capital measures by two Greek banks, the actual capital shortfall decrease to 7 bn Euro.

Overall, an aggregated capital impact of 263 bn Euro was identified for all participating banks under the adverse scenario. The vast majority of the capital impact is attributable to the stress test (180 bn Euro) and another 35 bn Euro to the AQR. An additional 47 bn Euro capital impact would result from an increase in risk weighted assets in the adverse stress case. The capital ratio (Common Equity Tier-1 = CET1) falls on average across all 130 banks tested in the Comprehensive Assessment from 11.8% to 8.4%, although the range is comparatively wide.

Considered on a country basis, three groups of countries can be identified, distinguished on the basis of relative impact on capital ratios:

  • Countries with stronger relative capital impact, averaging over 40%: Italy, Greece, Slovenia, Portugal, Belgium, Ireland and Cyprus. It seems that these countries, which were most impacted in the Comprehensive Assessment, also suffered most in the financial crisis.
  • Countries with relatively little relative capital impact (up to 25%): Spain, France, the Baltic states and Slovakia. These positive results seem to be related to the more data-driven approach to supervision or strong economic perspectives in the Baltic states.
  • Countries with medium relative capital impact (between 25% and 40%): Germany, Austria, the Netherlands, Finland and Luxembourg.

Overall, the results show that banks in countries where the supervisor has been pursuing a more data-driven supervisory approach have - on average - performed better than in other countries. Based on an index developed by Strategy& for data-driven banking supervision, two countries have the highest score: France and Spain. At the lower end of the scale are countries like Greece, Slovenia and Cyprus.

Effect of state aid on individual banks varies
Findings are highly dependent on whether banks have received state aid in recent years. While 62 of the overall total of 130 banks that had claimed assistance from the state have a higher average capital impact, the 28 banks in particular that are currently still implementing a restructuring plan show a significantly higher relative capital impact of 43% than the average across all banks, of 30%.

Objectives of the comprehensive assessment achieved – but only indirectly
“The objectives that were being sought in carrying out the comprehensive assessment were largely achieved, even if to some extent only indirectly," sums up Dr. Philipp Wackerbeck, a partner and finance expert at Strategy& (formerly Booz & Company). In particular, the AQR increased the transparency of those banks that fall under the ECB’s Single Supervisory Mechanism (SSM), taking effect from 4 November. The desired improvement in the banks' capital ratios (“repair banks through increasing capital”) was achieved, albeit not so much through the results of the test – only the 13 banks failing the test are required to submit capital plans within two weeks to show how they intend to close the capital gap of 9.5 bn Euro within six to nine months following the test. When subtracting the two Greek banks that already announced such capital measures, a shortfall of 7 bn Euro remains for the 11 banks. Instead, banks have already proactively increased their capital in the first nine months of 2014, by 40 bn Euro, even ahead of the results being notified. Whether the third aim, of restoring investor trust in the banking sector in the Eurozone, has been achieved will depend on the interpretation by market players in the days ahead.

Long-term effect, particularly of the AQR
While the stress test had a higher effect on the capital ratio, the outcome is likely to be of importance mostly in the short term, particularly for those banks which passed the test. Conversely, the AQR is set to have a longer term effect, even though its influence on capital ratios is lower than the stress test. For instance, carrying out the AQR with an examination of several tens of thousands of credit files, collateral revaluations and an analysis of the classification of problem loans made clear that in some cases there are large difference between the banking supervisory regimes of individual countries. The assumption of a common banking supervision role by the ECB for system-relevant banks will lead to a harmonisation across the Eurozone especially by fostering consistent definitions of Non-Performing Loans. This will make the analysis of bank balance sheets more comparable which itself is fostering financial integration and cross-border consolidation.

Continuing pressure on not sustainable business models
However, the comprehensive assessment is also subject to clear limitations. The exercise was a point-in-time assessment of the accuracy of the carrying value of banks’ assets as of 31/12/2013 (AQR) with the stress test providing a forward-looking examination of the resilience of banks’ solvency to two hypothetical scenarios. Conversely, the findings do no permit any judgement as to the solidity of the underlying business models of individual banks. According to Wackerbeck, “banks that were already unable to demonstrate a convincing business model with sustainable profitability before the comprehensive assessment will continue to be under pressure to revise their business model. That applies particularly for those banks that passed the test while widely-held market expectations were suggesting failure.”

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