The euro area banking system remains resilient in the face of an adverse macroeconomic scenario, as demonstrated by the stress test for banks under the supervision of the European Central Bank (ECB).
A total of 38 banks included in the sample of the European Banking Authority (EDF) and another 51 medium-sized banks supervised by the ECB participated, including the three Cypriot systemic banks, Bank of Cyprus, Hellenic Bank and RCB Bank. For the first time, the ECB publishes information on individual banks that were not included in the EBA contingency exercise.
Regarding the Cypriot banks, the results for the unfavorable scenario show that the capital ratio of common shares of category 1 (Common Equity Tier 1 – CET1) of Bank of Cyprus and Hellenic Bank would fall below 8% and would be between 11% to 14 % for RCB Bank.
According to the ECB, the average CET1 final score for 89 banks under the ECB supervision in a three-year unfavorable scenario is 9.9%, ie it fell by 5.2 percentage points from the starting point (15.1 %). Key factors that contributed to the reduction in capital are credit risk, market risk and the ability to generate revenue.
Analytically based on the results of the simulation exercise, the Common Equity Tier 1 (CET1) of the 89 banks participating in this exercise would fall from 15.1% to 9.9%, ie by 5.2 percentage points on average, if these banks were exposed to a three-year period of extreme situations characterized by adverse macroeconomic conditions. The CET1 index is a key measure of a bank's financial soundness. The 89 banks together represent slightly over 75% of the total banking sector assets in the euro area.
EBA published on Friday the results of the individual banks that participated in the stress test at EU level. These results include detailed data for the 38 euro area banks included in this sample. For the first time, the ECB also published selected information on the 51 medium-sized banks that are not included in the EBA sample.
There is no question of success or failure in the stress simulation exercise and no limit is set in order to determine the failure or success of the banks for the purposes of the exercise. Instead, the findings of the exercise will be incorporated into the ongoing supervisory dialogue.
Banks were better off at the start of the year than they were three years ago, but the system-wide capital reduction was higher. This is due to the fact that the scenario was much worse compared to the scenario used in the 2018 exercise.
The average total capital reduction was 5.2 percentage points and is analyzed as follows. For the 38 banks that participated in the EBA exercise, the average CET1 index fell by 5 percentage points, from 14.7% to 9.7%. The average capital reduction for the 51 medium-sized banks that participated exclusively in the exercise of the ECB corresponded to 6.8 percentage points, ie the relevant index fell to 11.3% compared to the starting point (18.1%).
The main reason for this difference in the capital reduction under the adverse scenario is that medium-sized banks are more affected by lower net interest income, lower net fee and commission income and reduced transaction portfolio income. three-year exercise horizon.
Also, according to the results, the first major factor that contributed to the reduction of the capital was the credit risk, because the financial turmoil in the unfavorable scenario led to losses from loans. Despite the overall resilience of the banking system, due to the new challenges posed by the coronavirus (COVID-19) pandemic, banks need to ensure that credit risk is properly measured and managed.
For a subset of banks, the second major factor contributing to the decline in capital was market risk. The fact that the value of many financial products had to be fully adjusted was the biggest single market risk factor. This has particularly affected the larger banks, as they are more exposed to stock and credit margins.
The third key factor was the limited ability to generate income in adverse economic conditions, as under the adverse scenario the banks were faced with a significant reduction in their net interest income, their trading book income and their net fee and commission income. .
Credit risk, market risk and revenue-generating capacity are the three main issues that ECB supervisors focus on in their day-to-day supervisory work.
Supervisors take into account some qualitative results of the stress test, such as the timely provision and accuracy of data as well as the quality of information, when assessing the governance and risk management of banks in the context of the annual Supervisory process. Review and Evaluation Process – SREP).
In addition, the quantitative impact of the adverse scenario of this exercise is a key element used by supervisors to determine the level of Pillar 2 (P2G) directions. The P2G guidelines are supervisory recommendations that indicate to banks the level of capital they should adhere to in order to be able to cope with extreme situations.
To provide temporary support to banks in terms of capital and operations during the COVID-19 pandemic, the ECB has committed itself to allowing them to operate below the P2G guidelines and the combined capital requirement at least until the end of the year. 2022. This timetable is not affected by the application of the new methodology for setting P2G directions. The ECB intends to give banks enough time to replenish their capital if the levels of the P2G directions increase.