On October 26, the ECB unveiled the results of stress tests conducted over nearly a year. These tests, carried out on 130 of the largest banks, representing 85% of eurozone assets, concluded that 13 banks were not sufficiently capitalized at that date (see table in appendix).
Why were these tests conducted?
These tests were launched at the end of 2013 in order to prepare for the establishment of the Single Supervisory Mechanism (SSM) on November 4, 2014, within the ECB. From that date, the SSM became the single supervisor of the 120 largest banks in the eurozone, replacing the national supervisors. These stress tests therefore serve to assess the health of European banks, a few years after the European debt crisis, to give the SSM an overview and establish its credibility as a supervisor.
What are these tests?
These tests were actually conducted in two stages by the ECB and the European Banking Authority (EBA). First, a comprehensive review of the assets held by banks (Asset Quality Review or AQR) was conducted between February and June 2014. This AQR provided the ECB with an opportunity to assess the quality of the securities and receivables held in the banks’ portfolios in order to estimate the risk of inherent losses.
In parallel with this AQR, a stress test of banks’ balance sheets was conducted between April and October 2014, based on the banks’ balance sheets as of December 31, 2013, and projecting their possible evolution between 2014 and the end of 2016. A baseline scenario, based on the European Commission’s forecasts at the beginning of 2014, was defined and, at the same time, an « adverse » scenario was prepared. The latter assumes a recession in the eurozone in 2014 and 2015, followed by stagnation in 2016 and inflation verging on negative territory.
The 130 banks concerned were subjected to these two scenarios, but with a balance sheet adjusted for the results of the AQR, which made it possible to eliminate the accounting differences that still exist between eurozone countries.
What are the main results?
The results of the stress tests indicate that 25 out of 130 banks were undercapitalized at the end of 2013 (see table in the appendix). However, taking into account the adjustments made by the banks in 2014 (reduction of asset portfolios, increase in capital), only 13 banks as of October 26, 2014, are still undercapitalized according to the tests.
More generally, the countries most affected are Italy (four banks) and Greece (two banks), whose banks will still need to raise €3.31 billion and €2.69 billion respectively. It is very likely that several of these banks will decide instead to merge with others that have healthier balance sheets.
What other conclusions can be drawn?
Despite the fact that major banks such as Deutsche Bank and BNP Paribas passed the tests, their capital ratios fell sharply in the adverse scenario. Deutsche Bank, BPCE Group, and Commerz Bank lost more than a third of their capital, while BNP Paribas and Société Générale lost a quarter. The process of strengthening the banks is therefore far from over.
Given the current situation, with inflation already at 0.3% in the eurozone, the adverse scenario of the stress test may seem overly optimistic and may not sufficiently reveal the risks faced by banks in the event of a macroeconomic shock. This echoes the first stress tests conducted by the EBA in 2010, whose credibility was seriously undermined when banks that had passed the tests subsequently found themselves in difficulty, such as Dexia.
In addition, these tests were conducted using definitions of CET1 or Common Equity Tier 1 (i.e., the core capital required as a provision), which still vary from country to country. With the transition to Basel III, convergence of the CET1 scope is underway, but the stress tests have not been adjusted for these differences. Germany, Spain, and Italy are particularly affected, with banks in these countries still needing to raise €32 billion, €25 billion, and €16 billion, respectively, to eventually comply with Basel III requirements, which affects the results of the stress test.
What are the consequences?
Banks that failed the tests will have to submit recapitalization plans by November 9 and will have either six months in the case of failure in the baseline scenario or nine months if they fail in the adverse scenario to implement them.
The two main objectives of these tests were to restore confidence in the eurozone credit markets andto assert the credibility of the new supervisor. While the success of these objectives can only be judged in the medium term, the results on October 26 are already contributing to this. The detailed publication of the tests will increase transparency and help restore market confidence.
And while the severity of the tests, which do not rule out a return of the old demons of the failures of previous tests conducted by the EBA, may be criticized, they do allow for a certain degree of discrimination in terms of the soundness of banks. Furthermore, the ECB has nothing to gain by upsetting financial markets that are already very cautious at the end of the year. Any alarming announcement concerning a major eurozone bank would only serve to weigh down an already very compromised recovery. It should also be noted that the ECB is simply not ready to manage a possible bank restructuring. The Single Resolution Mechanism is still being set up and the resolution fund simply does not exist. The credibility of the new supervisor is therefore not yet fully established, as long as it does not have all the necessary tools at its disposal (see the three pillars of the Banking Union).
