3 banks fail EU stress test.

European Banks Fail Stress Test, Raises Concerns but Shows Resilience

European banks faced a challenging test recently, with three major banks failing to meet binding capital requirements. The stress test conducted by the European Banking Authority (EBA) resulted in a theoretical loss of 496 billion euros ($546 billion) from the banks’ buffers. This setback raises concerns about the stability of the banking sector, but it also demonstrates its resilience.

Bank stress tests became an essential part of the banking supervision process after the global financial crisis in 2008. These tests were initiated to ensure that banks can withstand stressed market conditions and support the economy effectively. As part of the routine supervision, the EBA conducted this recent stress test, covering 70 banks, 57 of which were from the euro zone and overseen by the European Central Bank (ECB). These 70 banks represent approximately 75% of banking assets in the EU.

The stress test results drew attention to several German banks, which ended up with modest capital cushions. Among the 14 German banks tested, eight fell below the EU average for CET1 (common equity tier 1) and leverage ratio, while six surpassed it. Interestingly, the banks that exceeded the average were primarily subsidiaries of U.S. banking giants such as Goldman Sachs and JPMorgan, or financing arms of companies like Volkswagen Bank.

One notable banking outlier in the stress test was La Banque Postale of France. The adverse scenario almost wiped out its capital, highlighting the impact of market shocks. However, La Banque Postale argued that this test did not account for a recent accounting rule change, which would have moderated the shock’s effect.

Although the EBA did not reveal the names of the three banks that failed the stress test, it provided crucial insights into the severity of the test. Described as the toughest one yet, the three-year scenario examined the impact of credit, market, and operational risk losses on the banks’ mandatory core capital buffer. It simulated a cumulative 6% slump in economic growth and significant declines in property prices.

At the test’s commencement, banks had an average buffer of 15% of their risk-weighted assets. However, they suffered losses of 496 billion euros throughout the test, depleting their capital buffers by an average of 459 basis points to 10.4% at the end of the third year. Although this reduction was smaller than in previous stress tests, it was still significant.

Despite these challenges, the stress test results reaffirmed the resilience of the EU banking sector, according to the European Banking Federation. While there is no pass or fail mark, the results serve as a basis for banking supervisors to assess whether additional capital requirements are necessary beyond the mandatory core buffer known as the total SREP capital requirement (TSCR).

Fortunately, under the adverse scenario, all but three banks met the TSCR, ensuring their ability to handle stressed market conditions. However, four banks did not meet the mandatory leverage ratio requirement, which provides a broader measure of capital to total assets.

The stress test also identified that 37 banks fell below capital levels during the third year, triggering limitations on payouts. It’s worth noting that Deutsche Kreditwirtschaft, an umbrella association representing the German financial industry, criticized the ECB’s approach, stating that the ECB’s markups in later stages of the test worsened the results and increased stress-related capital losses. Nevertheless, the association praised German banks for their resilience overall.

Moreover, conducting an ad-hoc analysis of banks’ bond holdings against a backdrop of rapidly rising interest rates revealed potential unrealized losses of 73 billion euros in February. If the EU’s economy experiences severe stress, this figure could more than triple.

While this stress test underscores the pressures faced by European banks, it also demonstrates their ability to adapt and remain resilient. By subjecting banks to rigorous scenarios and stress testing their capital buffers, authorities can ensure that the banking sector can weather future turbulent times. Furthermore, these tests provide valuable insights and encourage banks to improve their risk management practices, ultimately contributing to the long-term stability of the financial system.

3 banks fail EU stress test.

European Banks Fail Stress Test, Raises Concerns but Shows Resilience

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