Commerzbank touts ‘robust’ capital in European Union stress test

Europe’s banking regulator, the European Banking Authority (EBA), released the highly anticipated results of this year’s “stress tests” of Europe’s 51 biggest commercial banks late on Friday evening.

“Based on these results European banks do have deeper loss absorbing capacity than previously, but concerns clearly remain around profitability and the appetite of equity investors to invest in bank stocks”, said Steven Hall of KPMG. Rather, the goal of the stress test was to compare and contrast large European Union banks to see how they would perform under an adverse scenario.

The Prudential Regulation Authority and the Financial Policy Committee will consider the results of the EBA stress test alongside the results of the 2016 Bank of England stress test, as part of their ongoing evaluation of the capital adequacy of both individual institutions and the overall resilience of the United Kingdom banking system.

Eight years since the collapse of Lehman Brothers sparked a global banking meltdown, many of Europe’s banks are still saddled with billions of euros in poorly performing loans, crimping their ability to lend and putting off investors. Germany’s largest bank outperformed Britain’s Barclays Plc, whose CET1 ratio dropped to 7.3 percent in this year’s test, which used December 31 as a cutoff date. That, in turn, will compound the headaches for political leaders, led by Italy’s Matteo Renzi and Germany’s Angela Merkel.

“Compared to five years ago, the ratio of highest-quality capital of European banks is now more than twice” said Wim Mijs, Chief Executive at the EBF. The review and evaluation processes aim to ensure financial institutions have the right strategies to cover the risks they face, including those highlighted by the stress tests.

Analysts expect banks that performed poorly under the stress tests will need extra measures to strengthen their balance sheets, including clearing non-performing loans off their books and raising fresh capital.

Publication of the regulatory stress-testing of BMPS and other troubled Italian banks should reveal whether Europe has another bailout emergency to deal with.

And it is just these risks that stress tests are created to invoke.

After Monte dei Paschi, the second biggest casualty in the EBA stress scenario is Allied Irish banks, with the Irish lender’s capital hammered down from 13.11 per cent to 4.31 per cent. Both lenders have been going through an increasingly rough patch because of lower profitability in the first half of the year coupled with the added costs of restructuring.

Still, the headlines are unwelcome for the two Irish banks and particularly AIB.

So what are stress tests and how do they work? Deutsche Bank said in a statement that it was on track to reach a core ratio of at least 12.5 percent by the end of 2018.

As resilience of banks has improved, challenges around qualitative aspects of the exercise – such as data quality and governance – have come to the fore on the ground with banks. Critics haven’t been quieted about the methodology and its discrepancies in how banks are judged. Rather, the oversight agency will assess whether banks would prove financially resilient in case of an extreme economic drop and market volatility.

The results of European bank “stress tests” are being announced later on Friday, with the aim of establishing how well the banks could cope with a new financial shock.