The results of the stress tests published by the European Banking Authority (EBA) on Friday 28 July show that the European Union’s banking sector “is sufficiently capitalised to continue to support the economy”, even though its cumulative losses would amount to €496 billion in the event of a very pessimistic scenario materialising.
The stress tests assessed how banks would react to the materialisation of credit, market and operational risks in the event of a drastic downturn in economic conditions. For the most pessimistic scenario, the following factors were taken into account over the three-year period 2023-2025: - a cumulative fall in EU GDP of 6%; - inflation well above the base scenario (+3 percentage points in 2023, 1.9 pp in 2024 and 1.5 in 2025); - a cumulative rise in long-term interest rates of 183 pp; - an increase in unemployment of 6.1% compared to the rate observed at the beginning of 2023; - a fall in share prices of 55% in 2023 and 43% in 2025; - a cumulative fall in property prices of 21% for the residential sector and 29% for the commercial sector.
According to EBA, if the worst-case scenario materialised, the proportion of CET1 capital of the panel of 70 banks would fall from 15% to 10.4%, representing a cumulative loss of €271 billion.
Compared with the stress tests carried out in 2021 (see EUROPE 12773/8), the loss would be smaller, despite a more severe adverse scenario this year, but would be more evenly spread across the industry. This is due to a starting point, at the end of 2022, where the banks are more robust in terms of CET1 capital and the quality of their assets is better, with a non-performing loan ratio of less than 2%.
In the worst-case scenario, only three banks would not be able to comply with the minimum prudential requirements for holding CET1 capital and four banks would not meet the leverage ratio requirements. However, EBA points out that the exercise is not intended to identify which banks pass or fail the stress tests, with the consequence of imposing new capital requirements on those financial institutions that would appear to be the least capitalised in the event of the adverse scenario materialising. The results of the tests are primarily intended to feed into the supervision that banking supervisors exercise over the banking groups under scrutiny.
One of the special features of the 2023 stress tests is the breakdown of observed losses according to banks’ exposure by sector. So, if the worst-case scenario materialises, the banks most affected would be those exposed to the accommodation and catering, manufactured goods and energy-intensive sectors.
In 2023, the panel analysed includes 20 more banks than in 2021, giving a total of 70 banks from the EU and EEA countries, including 57 from the euro area. In total, 75% of total banking assets are covered.
In its banking stress tests, the EBA did not analyse liquidity risk, in reference to the causes of several bank failures observed this spring in the United States. The same applies to climate risk. At the same time, the European authority is developing a methodology to test the financial sector’s ability to meet the requirements of the ‘Fit for 55’ legislative package.
“European banks have proven to be resilient against real-life events, from the Covid pandemic, the war in Ukraine, and the recent turmoil within the US regional banking system”, Wim Mijs, speaking on behalf of the European Banking Federation, said in a statement.
See the results of the banking stress tests: https://aeur.eu/f/8a8 (Original version in French by Mathieu Bion)