9th November 2018

Scope asks what the EU stress tests really tell us

The latest EU stress tests may have demonstrated that banks’ efforts to build up capital in recent years have contributed to a greater capacity to withstand severe shocks and material capital impacts. But how relevant are the latest round of tests?

The EBA’s bottom-line conclusion was that the EU banking sector is fundamentally sound. The results of individual banks’ stress tests clearly diverged and therefore supported the overall sector narrative to a greater or lesser extent. But there were no real surprises and the results in any case have very limited utility.

So what does the exercise prove? “On the plus side, analysts and investors have been more than happy to rely on a visible metric to anchor their views. And the CET1 ratio has been a highly visible anchor – with the added advantage of having a live-or-die regulatory imprimatur,” said Sam Theodore, team leader for financial institutions at Scope Ratings.

In that context, stress tests offer regulators, supervisors and market participants an opportunity to rank banks as a method of picking winners and losers, even if they are based on a constant balance sheet that is almost a year old implying no management action so will not to alert investors to the risks they should be most concerned with in regard to the banks they follow.

“Having publicly concluded some time ago that banks had reached a reassuring level of capitalisation, European regulators were clearly in no mood to plant the seeds of another banking panic. Perhaps more to the point, they were in no mood to plant the seeds of another banking crisis that they might be blamed for.

“The political environment the EU finds itself in is more fickle today than it was at the time of the ‘fight the crisis’ consensus of 10 years ago. The ECB is still at the end-stage of its QE programme and rates remain rock-bottom. This suggests that should a new banking crisis come about, the ‘whatever it takes’ mantra may be less reassuring than last time around.”

To conduct the stress tests, the EBA relied on bank data provided by the ECB-led Single Supervisory Mechanism and competent national authorities, and worked with them throughout the process. “There was no plausible reason to expect regulators to have produced last-minute surprises to upset the markets unnecessarily, when those same markets are facing other issues, from national politics to geopolitics, cyber-attacks, money laundering, and other threats not easily addressed by the old over-utilised metrics.”

How will banks cope with a successful cyber-attack? How will episodes of misconduct – from market abuse, money laundering and financing the ‘wrong’ people to issues of taxation – affect funding costs and the ability to issue new capital at economically viable prices?

“These are very real but, to-date, ‘un-stressable’ risks. To the extent that the system can cope with such risks, it seems undeniable that they are best addressed through proper governance and management and pro-active supervision. After all, threats to banks will hit funding costs before they start eating into regulatory capital.”