European banks show continued resilience despite tougher stress test
The latest EU bank stress tests suggest that the banks’ strengthened capital ratios should ensure that they remain resilient, even if the region drops into an elongated recession. As noted in a report, the regulatory exercise also shows that structural profitability remains the Achilles’ heel of many European banks.
The 101 banks that participated in the EBA and ECB’s stress tests generally performed well under stress assumptions that were tougher than the last exercise in 2018. Furthermore, under the regulators’ base-case assumptions, the vast majority of European banks would remain comfortably profitable during 2021-2023, even if they have to make significant top-ups to credit provisions. For many, this will support regulatory acceptance of their shareholders’ distribution plans after the ECB’s recent removal of its 2020 prohibition of such payments. However, regulators are likely to constrain these distribution requests for banks that showed steep capital ratio declines under the stress test.
“At this point, we don’t expect the results of the stress tests, including possible capital return, to lead us to change ratings on any of the banks that were tested,” said S&P Global Ratings credit analyst Giles Edwards. While we will dig deeper into the results on individual banks and discuss the results with management, we saw no major surprises in the results. Our ratings typically already incorporate a forward-looking expectation of a moderate reduction in capital ratios as distributions restart.
Under the adverse case, the EBA and ECB exercises show similar aggregate results: a larger reduction in capital ratios than in the 2018 exercise (a drawdown of about 5% vs. 4% before), but a similar end point of 10% common equity tier 1 (CET1). Taking into account that the 2021 scenario assumptions were tougher than in 2018 and banks’ starting point capital ratios were higher, system resilience improved over the past three years.
As before, though, individual banks’ results showed wide variations around the average. The main drivers of depleted profitability were, in order, spiking loan losses, trading losses, and shrinking net interest income. Rising, procyclical RWAs also contributed significantly to the modelled depletion in capital ratios.
“The base-case results align with our sectoral view in many respects,” he added, “notably that under returning economic growth, European bank credit quality is at greater risk from weak structural profitability than from persistent elevated credit losses. Furthermore, as the stress test outcome shows, already-weak pre-provision profitability could still deteriorate markedly if economic growth contracts further.”
This report does not constitute a rating action.