80% ECB Banks Pass Stress Test

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More than six years after the financial crisis, European banks emerged as healthier. This is per the outcome of the stress test conducted by the European Central Bank (:ECB) based on 2013-end data.

Of 123 banks that were part of the stress test, only 24 failed to meet the minimum common equity ratio (:CET1) level of 5.5%. On an average, the banks’ CET1, under adverse macroeconomic scenario, fell from 11.1% as of Dec 31, 2013 to 8.5% by the end of 2016.

Additionally, overall capital shortfall was €24.6 billion ($31.2 billion), as of Dec 31, 2013. Nonetheless, the banks made significant progress in lowering this gap and strengthened their capital base. Hence, as of Sep 30, 2014, the shortfall stands at €9.5 billion.

The ECB also reviewed the asset quality of the banks’ balance sheets, in order to determine the accuracy of the value of mortgages, investment and corporate loans. This led the banks to lower the value of their assets by €47.5 billion. Further, the ECB identified €135.9 billion of additional non-performing assets in the banks’ balance sheet.

Successful Banks

Majority of the large global banks in the Eurozone were able to clear the stress test. Some of these included the German-based Deutsche Bank AG (DB) and Commerzbank AG; France’s BNP Paribas SA (BNPQY), SociétéGénérale (SCGLY) and Credit Agricole S.A. (CRARY); Italian bank UniCredit S.p.A. and Spain’s Banco Santander, S.A. (SAN).

Apart from these, all four major banks of U.K . – HSBC Holdings plc (HSBC), Barclays PLC (BCS),The Royal Bank of Scotland Group plc (RBS) and Lloyds Banking Group plc (LYG) – were able to pass the stress test.

Banks that Failed

Mainly the banks located in Italy, Cyprus and Greece were the ones that failed to clear the stress test. Of the total 24 banks that failed, nine were Italy-based, including Banca Monte deiPaschi di Siena SpA, Banca Carige SpA, Banca Popolare di Milano SCARL and Banca Popolare di Vicenza ScpA.

Apart from these, three banks each in Cyprus and Greece did not clear the stress test, with National Bank of Greece SA (NBG) being one of them. Other banks that failed are located over Germany, France, Spain, Portugal and Belgium, among others.

Notably, nearly half of the failed banks have already filled up their capital shortfall, as of Sep 30, 2014. Others have been granted two weeks’ time to inform the regulators about how they plan to fill the deficits. Further, these banks will be given nine months to implement those plans.

Backdrop & Scenarios for Stress Test

This is the fourth attempt (earlier ones held in 2009, 2010 and 2011) by the ECB to conduct the stress test, with the latest being the clearest and most rigorous in terms of scenarios defined and overall review done by the regulators. Earlier ones had several shortcomings and failed to spot problems. Banks deemed healthy had collapsed within weeks or months, making a mockery of the so-called stress test at that point.

The primary aim of the stress test is to gauge how much the banks would lose in case of a future economic downturn. The test rounds aid in determining how banks would respond to another economic slowdown and a slump in the markets. Hence, the ECB has come up with hypothetical scenarios that were considered while conducting the stress test.

All the hypothetical scenarios include stressed commercial real estate market and foreign exchange rates. Further, a significant rise in unemployment rate, anticipated changes in EU GDP and a substantial weakness in advanced economies including Japan and the U.S. form part of the stressful circumstances.

Road Ahead

The top priority of the ECB conducted stress test remains the restoration of confidence on the still shaky banking sector and prevention of any more crises similar to those that shook Spain, Cyprus and Ireland recently. The aim is somewhat identical to the annual stress test conducted by the U.S. Federal Reserve.

Actually, the Fed started the annual stress test in 2009 with an aim to prevent any future collapse of the financial market. In case of stress test failure, the U.S. regulator prevented banks from paying dividends and buying back shares. This aided the American economy to recover faster than Europe.

Now, the ECB has started tightening its hold over the Eurozone banks, similarly aiming at a faster recovery of the European economy. With this tougher stance, banks are likely to raise additional capital to strengthen their balance sheet and buffer themselves against another financial meltdown.

We believe that such measures would surely improve Europe’s financial stability and aid the overall global economic recovery as well. Further, this will improve the lending capacity of banks, thereby bolstering their financial position.

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