ECB: Stress test shows improved resilience

The results of EU-wide bank stress tests show that euro area banks improved their resilience and overall supervisory capital expectations will remain broadly stable compared to 2015, the European Central Bank (ECB) said.

The stress test coordinated by the European Banking Authority (EBA) for 51 banks in the European Union included 37 significant institutions directly supervised by the ECB, covering about 70% of banking assets in the euro area. The 37 ECB supervised banks entered the test with an average Common Equity Tier 1 (CET1) capital ratio of 13%, an improvement on the 11.2% in the last EU-wide stress test in 2014, the ECB said.

In the adverse scenario, the average capital depletion was 3.9 percentage points, higher than the 2.6 percentage points in the 2014 stress test. This was partly due to a more stringent stress test methodology and a tougher adverse scenario that covered again a three-year period and assumed static balance sheets. Thanks to a higher capital level and other improvements since 2014, the final average CET1 ratio in the adverse scenario was nonetheless higher at 9.1%, compared to 8.6% in 2014.

With one exception, all banks show CET1 capital levels well above the benchmark of 5.5% used in 2014 in the hypothetical adverse scenario, the ECB said. This reflects the robustness of overall capital levels at the banks tested in the EBA led stress tests.

“The results reflect the significant amount of capital raised and the additional balance sheet repairs by the banks over the past two years,” said Daniele Nouy, Chair of the ECB’s Supervisory Board. “The banking sector today is more resilient and can much better absorb economic shocks than two years ago.”

In the stress test’s adverse scenario, the capital depletion, which was on average 3.9 percentage points, was due to various risk drivers:

- Credit risk contributed on average 3.8 percentage points to the overall CET1 depletion.

- Market risk contributed on average 1.1 percentage point, predominately as a result of revaluation losses on assets booked at fair value.

- Operational risk contributed on average 0.9 percentage point due to loss projections for conduct risk, an element introduced in the 2016 exercise for the first time.

In addition, a mix of other factors positively or negatively influenced the capital depletion, including net interest income, income from fees and commissions and administrative expenses. Income factors were stressed as well. In particular, net interest income was significantly stressed in the adverse scenario, with an impact of 1.3 percentage point when compared to the baseline scenario.

Although the stress test is not a pass/fail exercise it will, however, contribute in a non-mechanistic way as one of several input factors to determine Pillar 2 capital in the ECB’s overall Supervisory Review and Evaluation Process (SREP).

Pillar 2 capital consists of two parts: Pillar 2 requirements and Pillar 2 guidance. The stress test results are used by the ECB in Pillar 2 guidance, taking additionally into account consequences of the static balance sheet assumption and banks’ mitigating management actions among other factors.