European banks have shown resilience in the face of a tougher stress test, according to a new report from the European Banking Authority (EBA).
The 2023 stress test, a more stringent evaluation that encompassed a severe EU and global recession, rising interest rates, and expanding credit spreads, demonstrated the banks’ ability to endure under demanding conditions.
The report highlights that higher earnings and superior asset quality at the beginning of 2023 assisted in tempering capital depletion under the adverse scenario. Despite combined losses of €496bn, the EBA has confidently stated, “EU banks remain sufficiently capitalised to continue to support the economy also in times of severe stress.”
With a total of 70 lenders being evaluated, 20 more than in 2021, the findings present a comprehensive insight into the European banking landscape. The banks’ fully loaded common equity Tier 1 (CET1) ratios fell on average by 459 basis points (bps) to 10.4% in the stricter scenario, a decrease somewhat less pronounced than in previous years.
However, Moody’s Investors Service has cautioned that comparing this year to previous years may not provide an accurate representation due to changes in scenario assumptions and test participants. The credit rating agency has observed that the deterioration in 2023 is more modest due to the banks’ better performance.
Digging deeper, Moody’s revealed that nearly one third of the banks did not comply with the CET1 requirement. But even here, the capital shortfalls were described as “very limited,” keeping those banks in good standing. Banks in Norway, Poland, and Sweden performed particularly well, while France, Germany, the Netherlands, and Spain exhibited below-average capital ratios.
A parallel test of 41 smaller institutions conducted by the European Central Bank (ECB) found a moderately larger hit to capital under stressed conditions for smaller banks. Moody’s noted, “This moderately higher capital depletion reflects smaller banks’ more focused business models and narrower asset diversification. This results in higher concentration risks and therefore higher losses.”
Climate risk, although not directly considered in the scenario, is now being addressed by the EBA through new mandates. These will assess the financial sector’s resilience in alignment with the Fit-for-55 package and the ability to support a lower-carbon economy even in stressed conditions.
In addition, the EBA has initiated a public consultation process to gather climate-related and financial data on various risks until October 11.
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