The much anticipated 2016 EBA Stress Test results will be unveiled tonight at 9pm BST. There is always a difficult balance to strike in this type of exercise as the test must be credible, and is therefore designed to result in a number of banks showing a capital deficit, and subsequently test some of the available solutions, i.e. capital actions must be ready in order to fill eventual gaps.
This year’s Stress Test is of limited scope and different in nature from the 2014 test which marked - as part of the comprehensive assessment (CA) - the beginning of the new banking supervision under the ECB. The Stress Test is not a pass/fail exercise (although many of those watching the banking sector cannot resist the temptation to view it as such). No hurdle rates or capital thresholds are defined for the purpose of this year’s exercise. The idea is rather to provide useful inputs into this year’s Supervisory Review and Evaluation Process (SREP), the annual conversation between the ECB and the 51 banks “stress-tested”. This conversation is finalised by November, when capital requirements for the banks are declared.
Yes, this year there is a focus on the asset quality of 51 banks, representing 70% of the total banking assets in the EU. However, in some recent communications between the Single Supervisory Mechanism (SSM) and Italy’s Monte dei Paschi di Siena, the SSM’s encouragement of the accelerated disposal of non-performing assets (NPA) by Monte has engendered confusion. It is important to remember that these new targets are the binding constraint for the most vulnerable Italian bank from the SSM, and not dependent on the results of the Stress Test per se.
There is already speculation of different banks considering steps such as selling financial assets and shares to raise capital. The more orderly the fashion in which this is carried out, the better. Looking back at the 2014 Stress Test, banks were given the customary 6 to 9 months window to raise capital. The existing rules offer some flexibility at the margins; a certain latitude to avoid potentially market-disrupting events such as a bail in. It is our understanding that the EU State Aid rules, with a focus on a level playing field, permits some degree of state support if done at market prices. It will be particularly interesting to see the stance taken by the European Commission, as Italy is far from the only country whose banks look vulnerable.
We will return to the 2016 Stress Test after the announcement and, what shall be more interesting, the “responses” from the banks. Stay tuned.
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