Europe-wide stress tests show big banks coming through a theoretical financial crisis in better shape than in the last such test two years go.
None of the 48 banks subjected to the exercise fell short of the capital yardstick used in earlier exercises, although this year’s exercise does not give pass-fail grades. The bar was cleared by all four Italian banks tested and by Deutsche Bank, which is trying to return to profit after three years of losses.
Italian banks are in focus because of their large holdings of government bonds, which lost value due to fears the populist government will run bigger deficits.
This year’s scenario, run by the European Central Bank and the European Banking Authority, involved a bigger shortfall in economic output than last time in 2016. Banks faced a 2.7 percent fall in economic output over three years, plus a ferocious bear market in stocks and steep declines in house prices. The scenario attempts to capture some of the known risks to the European economy, including those associated with Britain leaving the European Union and a sudden drop in Sweden’s sky-high house prices.
The stress tests are part of a broader effort to strengthen banking regulation and the banking system in the European Union in the wake of the Great Recession global financial crisis a decade ago, and the eurozone debt crisis that peaked in 2011-2012.
The results showed that on average banks were left with capital padding of 10.3 percent of their assets, measured as their core tier 1 equity ratio. That is a widely used measure of bank financial strength and ability to cope with losses on investments and loans that don’t get repaid. This year’s average strength compared to 9.4 percent in the 2016 stress test of 51 banks under a different scenario.
Although the results are not pass-fail, all the banks exceeded a 5.5 percent capital yardstick used in a 2014 test and which remains a key metric for regulators and investors. The results of the test will now be digested by the European Central Bank’s banking supervisory arm. That process could result in weaker banks being asked to raise money or take other steps to improve their finances.
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