Despite facing the most severe stress test to date, the EU’s largest lenders have come out the other side in relatively good shape. Only two banks out of 50 had capital ratios below requirements.

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The European Banking Authority’s (EBA’s) stress test results, released on July 30, show that the EU banking sector has enough capital to withstand severe economic strain over the next three years. This is in spite of the agency setting its toughest assumptions since the tests began in 2009.

The EU-wide stress test uses 2020 end-of-year data to analyse how a bank’s capital position develops until 2023, under both a baseline and an adverse scenario. The EBA’s adverse scenario included a long‐lasting recession resulting in a 3.6% decrease in real gross domestic product, a 4.7% increase in the EU unemployment rate and a 21.9% drop in residential property prices. Climate risk is not explicitly considered, as methodologies to embed it in a stress test framework are still being developed, according to the EBA.

Under the adverse scenario, unsurprisingly banks’ capital ratios took a hit. The aggregate common equity Tier 1 (CET1) ratio dropped by 485 basis points (bps), resulting in €265bn CET1 reduction, compared with a decline of 395bps during the previous test in 2018. However, because the sector overall started with a better capital position and asset quality, the average fully-loaded CET1 position is 10.2%, versus 10.1% in 2018.

Overall, banks in Belgium, Hungary, Norway, Poland and Sweden fared better than average, while those in Germany, Ireland, Italy and Spain performed worse.

Banks in Belgium, Hungary, Norway, Poland and Sweden fared better than average, while those in Germany, Ireland, Italy and Spain performed worse

Banca Monte dei Paschi di Siena (MPS) was the worst performer among the 50 banks with a fully-loaded CET1 ratio at -0.1% at year-end 2023 in the adverse scenario. In comparison, UniCredit, which announced plans to take over parts of MPS, ended the test with a CET1 ratio of 9.59%.

HSBC Continental Europe, the French arm of the UK bank, was the other lender that fell below the minimum CET1 ratio of 6% set by the Basel Accords, coming in at 5.9% in the adverse scenario.

Credit risk remains the main driver of capital depletion, according to the EBA, but there is a higher impact on net interest income (NII) compared to previous stress tests. The results also show a scattering across banks, with those more focused on domestic activities or with lower NII displaying a higher depletion rate.

The 2021 exercise covers 38 lenders from euro area countries and 12 banks from Denmark, Hungary, Norway, Poland and Sweden, representing about 70% of the EU’s total banking assets. UK banks are no longer in the sample this year, following the country’s exit from the EU.

The EBA plans to conduct a transparency exercise in December 2021 with a wider sample of about 130 EU banks.

Joy Macknight is editor of The Banker. Follow her on Twitter @joymacknight

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