(Tiper Stock Exchange) – The euro area banking sector would be able to weather a severe economic downturn. This was stated by the European Central Bank (ECB) by publishing the results of the 2023 stress test. The common equity tier 1 ratio (Common Equity Tier 1, CET1) of the 98 banks participating in the exercise would decrease by an average of 4.8 percentage points, reaching 10.4%, if it were exposed to three years of tensions in very difficult macroeconomic conditions. The CET1 ratio is a key measure of a bank’s financial strength.
The ECB subjected to the stress exercise 98 banks over which it supervises directly. Of these, 57 represent the largest euro area credit institutions that are included in the EU-wide stress test coordinated by the European Banking Authority (EBA), while 41 are medium-sized banks not included in the EBA sample. Together they make up around 80% of the total assets of the euro area banking sector.
Credit and market risks as well as the lower ability to generate income determined the negative capital impact in the adverse scenario. at credit losses a decrease in the CET1 ratio of 4.5 percentage points is attributable; unsecured retail portfolios were found to be the most vulnerable. Banks also had to submit loan loss projections by sector and projections of highly leveraged exposures of the loan and underwriting portfolio. Examination has shown that the highly leveraged exposures are riskier in an economic downturn and that many banks need to improve their underwriting, modeling and data aggregation capabilities.
At the same time, 1.4 percentage points of the overall capital erosion is attributable to market riskin particular to the effects of revaluation deriving from positions valued at fair value. Banks’ ability to generate income is also reduced in the adverse scenario, with a decline in net interest income, dividends and net fee and commission income, which together account for 3.6 percentage points of the decrease in CET1 compared to the scenario Basic.
“Importantly, the stress test has shown that banks’ ability to generate net interest income in an adverse scenario characterized by rising interest rates depends crucially on their business model and related asset and liability structure. liabilities – the report reads – For example, banks that have a higher share of floating-rate loans benefit more from rising interest rates than those that mainly issue fixed-rate loans. ECB urges banks to pay particular attention to how interest rate risk is managed“.
L’capital erosion at the end of the three-year time horizon was less compared to previous stress tests, mainly because overall the banks entered the exercise in better conditions, with higher quality assets and higher profitability. For some institutions, the quality of the loan portfolio has improved significantly since 2021.
The smaller banks included in the ECB’s sample experienced higher capital erosion than the largest ECB-supervised companies (6.6 percentage points vs. 4.6 percentage points), as a result of lower income-generating capacity and higher losses on receivables over the projection horizon. However, the CET1 ratio of smaller banks remained higher than that of larger counterparties (13.7% vs. 10.1%) as the starting level was higher (20.2% vs. 14 .7%).