Bank capital: Italy worries mask wider malaise in Europe
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Bank capital: Italy worries mask wider malaise in Europe

Benign scenarios used by EBA; CCAR reveals greater capital shortfalls.

The timing of this year’s EBA bank stress test results could hardly have been worse, coming as they did just weeks after the UK’s shock vote to leave the EU. Some weaker bank stocks – particularly Italian ones – were battered by the Brexit decision, and then were quickly floored again by the EBA’s conclusions.

Giovanni Sabatini-160x186

Giovanni Sabatini,
Italian Banking

Banca Popolare was trading at €3.03 on June 23, fell to €2.32 the following day, recovered to €2.52 by July 29 and then slumped again to €2.39. Even one of Italy’s stronger banks, Intesa Sanpaolo, went from €2.26 on June 23 to €1.74 the next day, recovered to €1.97 and then fell again to €1.90.

This pattern was repeated across the Italian banking sector, although the tests showed that while the 51 EU banks tested had a cumulative capital shortfall of €51 billion, only one bank – Banca Monte dei Paschi di Siena – would see its capital wiped out in an adverse scenario: it would actually record a negative common equity tier 1 ratio of -2.23%, down from 12.01% at the beginning of 2015.

However, if the performance of other bank stocks is anything to go by, investors are equally, if not more, concerned about other banks in Europe. Deutsche Bank’s share price fell from €15.57 on June 23 to €13.37 the following day and continued falling. On July 29 it stood at €12.03 and by August 2 was €11.24. In the immediate post-EBA results fallout, BNP Paribas’ share price was €47.70 on June 23 and €36.91 on June 27; back up at €44.36 on July 29 but down to €41.81 by August 2. 

The EBA tested for a decline in equity prices of 25% over three years, which in the context of current markets is pretty benign. At the beginning of August three academics led by Viral Acharya at the NYU Stern School of Business published analysis of what the capital shortfalls among the 51 EBA-tested banks in Europe would look like if the US equivalent stress test – the Comprehensive Capital Analysis and Review (CCAR) – had been applied instead. CCAR tests for a 4% leverage ratio rather than the 3% used in Europe.

If the CCAR rules are applied, the total capital shortfall of the 51 banks shoots up to €123 billion, largely due to banks breaching the tier-1 leverage ratio. The bank with the largest shortfall under this measure is Deutsche Bank with €19 billion, followed by Société Générale (€13 billion), and BNP Paribas (€10 billion). MPS has a capital shortfall of €8.5 billion, UniCredit €8.8 billion, and Banco Popolare €700 million. Capital shortfalls are particularly large among German banks (€24 billion), French banks (€23 billion) and Italian banks (€18 billion) under CCAR rules. 

The stress tests are based on scenarios and are not objective. They are simulations. You may think they are realistic or unrealistic - Giovanni Sabatini, Italian Banking Association

The academics then analysed the capital strength of the banks in a systemic crisis (where the stock market declines 40% in six months). While the 34 publicly listed banks in the EU stress tests had a capital shortfall of €92 billion under CCAR, under systemic crisis conditions this balloons to €640 billion. The disparity in capital needed between CCAR and a systemic risk is shocking: Crédit Agricole would be short a further €79 billion, BNP Paribas €75 billion and Deutsche Bank €60 billion. 

Indeed, in a systemic crisis France has the greatest capital shortfall: its banks lack €248 billion capital, 12% of French GDP. The capital shortfalls in the banking sectors of Germany, Spain and the UK are all worse than that for Italy, with capital shortfalls in Spain and the UK accounting for a greater percentage of national GDP (11% and 7% respectively) than that for Italy.


It is not surprising that Italy’s bankers have expressed frustration with the process.

Giovanni Sabatini, general manager at the Italian Banking Association, argues that the entire stress testing process is unfair in that it produces results based on subjective simulations that trigger unjustified volatility in the market. “The regulatory approach is imbalanced. There is also an issue in terms of communication that prudential supervisors and market supervisors should try to solve,” he says. 

“Today the prudential supervisors are using tools based on more subjective assessment. The stress tests are based on scenarios and are not objective. They are simulations. You may think they are realistic or unrealistic. You may oversimplify the models you are using. The last stress tests were done over a time horizon of three years. They used a static balance sheet for each bank over that time. That is like saying someone would stand there while someone was banging them over head and wait to see when their head breaks open.”

The academic research also shows that capital shortfalls among all the banks examined increased by 35% between November 2014 and June 2016 – raising legitimate questions over the usefulness of the exercise. However, while the position for Italian banks worsened by 29%, capital shortfalls at Spanish banks increased by 110% from €55 billion to €117 billion over this period. Germany has the greatest shortfall as a multiple of banks’ market value of equity, at 4.7 times.

“Information on stress tests should remain confidential as it may trigger volatility and disturbance,” demands Sabatini. “The analysis should remain confidential between the supervisor and the supervised entity. If there is a real lack of capital due to an objective assessment, then this should become public.”

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