Monte Paschi Fails European "Stress Test" Meant To Restore Confidence In Europe's Struggling Banks

Moments ago, the European Banking Authority published the 2016 bank stress test results, whose purpose - as every other year -  is to inspire confidence in Europe's struggling banks; it differs from a market-based assessment of bank stress - that particular "test" can be seen by observing the stock prices of such giant banks as Deutsche Bank and Credit Suisse, both of which recently hit all time lows.

As previewed yesterday, Italy's 3rd largest, and most insolvent bank, Banca Monte di Siena was the worst performer in European regulators’ stress tests, and the only lender to have its capital wiped out in the exam.  According to Bloomberg, Monte Paschi’s common equity tier 1 capital ratio, a key measure balance sheet strength, would to a negative 2.2% in an adverse economic scenario, the test revealed, which put lenders through a simulation of a severe recession over three years. Another Italian bank, UniCredit, would see its ratio fall to 7.1% , the second-worst result of the five Italian lenders being examined.

Needless, to say, the test - as structured - was a farce from the beginning as it did not account for negative interest rates, something Europe has trillions of, nor did it test for Brexit. Finally, the test did not include any banks from Greece of Portugal, where virtually all banks are currently insolvent.

While the exam of 51 lenders is breaking with past practice by having no pass/fail mark, it’s intended to give supervisors across the European Union a common basis for measuring and bolstering lenders’ financial resilience. The test has taken on additional importance as the Italian government weighs methods to shore up Monte Paschi, and the capital shortfall identified in the test may open the door to public support.

“The EBA’s stress test is not a pass or fail exercise,” Andrea Enria, chairman of the EBA, said in a statement releasing the results Friday. “Whilst we recognize the extensive capital raising done so far, this is not a clean bill of health. There remains work to do.”

The summary of results is shown below:

The detailed breakdown with full capital impairments under an "adverse case", which does not test for NIRP at all - i.e., Deutsche Bank's biggest complaint - is below.


As shown above, Allied Irish Banks, the second-poorest performer in the adverse scenario, had a CET1 ratio of 4.31%. Deutsche Bank AG’s ratio fell 3.32 percentage points to 7.8 percent through 2018 from its starting point under the adverse scenario. What is most ironic, is that DB's biggest lament, and the reason why it posted a 98% plunge in profit, namely NIRP, was not even contemplated in the "adverse case."

The farcical test also revealed that more than three-quarters of the 51 lenders maintained a CET1 ratio of more than 8%.

The legal minimum for all banks is a CET1 ratio of 4.5% , in other words European bank regulators are praying that investors will believe that one Italian bank is the only one that needs an urgent capital injection. Incidentally, just minutes before the announcement of the stress test, Monte Paschi announced that it had managed to obtain the needed €5 billion in fresh outside private capital.

Regulators also ask banks to hold another 3.5% of risk-weighted assets in subordinated debt, as well as a series of buffers, which are made up of common equity. On top of that, supervisors add additional requirements for each lender, while banks deemed systemically important must have an extra cushion of capital to help absorb the damage their failure would cause.

The European Central Bank, which supervises 37 of the lenders in the test, has said it will use a 5.5% ratio in the stressed scenario as an informal benchmark for lenders’ resilience. The final requirement set will move up or down from that level to take account of banks’ individual business models.

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The adverse scenario applies shocks to economic output, interest rates and exchange rates, as well as plunging real estate prices. As noted above, analysts have questioned the reliability of the exam because the scenario doesn’t include flat or negative interest rates, the U.K. decision to leave the EU, and doesn’t include any lenders from Portugal or Greece.

In other words, the test - which in previous years "passed" such failed banks as Spain's Bankia and Belgium's Dexia, is mere whitewash, designed to boost confidence in Europe's banking sector.

And with DB stock recently trading at all time lows, we doubt it will succeed. Notably, Deutsche Bank CEO John Cryan has sent a reassuring note to staff but ends with a somewhat ominous tone:

"Our environment is challenging and may become more so in the months ahead. The stress test results indicate that Deutsche Bank is well-equipped for tough times."

As we reported earlier today, Monte Paschi approved a plan to tap investors for the third time in two years by selling stock to replenish capital, according to a board member. While Monte Paschi is seeking to raise funds through private means, Italy has held talks with the European Commission seeking approval to back the bank’s recapitalization with state funds. Italy’s lenders are saddled with about 360 billion euros of non-performing loans, a legacy of years of economic stagnation. Unlike Spain’s bailout in 2012, the Italian authorities didn’t force banks to resolve the situation. The ECB has now taken over supervision of the country’s biggest lenders and its demands for action have helped bring matters to a head.

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Here is the official statement from the EBA:

EBA publishes 2016 EU-wide stress test results

  • From a starting point of 13.2% CET1, the stress test demonstrates the resilience of the EU banking sector to an adverse scenario with an impact of 380 bps CET1 on average
  • The stress test does not contain a pass/fail threshold. It will instead inform supervisors'  ongoing review of banks and guide their efforts to maintain capital in the system and support the ongoing repair of balance sheets
  • Exceptional transparency is provided, with over 16 000 data points per bank, to foster market discipline

The European Banking Authority (EBA) published today the results of the 2016 EU-wide stress test of 51 banks from 15 EU and EEA countries covering around 70% of banking assets in each jurisdiction and across the EU.  The objective of the stress test is to provide supervisors, banks and other market participants with a common analytical framework to consistently compare and assess the resilience of large EU banks to adverse economic developments.  Along with the results, the EBA is providing again substantial transparency of EU banks' balance sheets, with over 16,000 data points per bank, an essential step towards enhancing market discipline in the EU.

The EU banking sector has significant shored up its capital base in recent years leading to a starting point capital position for the stress test sample of 13.2 % CET1 ratio at the end 2015. This is 200 bps higher than the sample in 2014 and 400 bps higher than in 2011.  The hypothetical scenario leads to a stressed impact of 380 bps on the CET1 capital ratio, bringing it across the sample to 9.4% at the end of 2018.  The CET1 fully loaded ratio falls from 12.6% to 9.2%, while the aggregate leverage ratio decreases from 5.2% to 4.2% in the adverse scenario.

The impact is driven by:

  • credit risk losses of €-349 bn contributing -370 bps to the impact on the CET1 capital ratio.
  • operational risk (€-105 bn or -110 bps) of which conduct risk losses contributed -€71 bn or -80 bps to the CET1 impact
  • market risk across all portfolios including CCR (€-98bn or -100bps).

The impact is partially offset by pre provision income flows, although these too are subject to stress factors and constraints in the methodology. For instance net interest income falls 20% in the adverse scenario from 2015 levels.

The 2016 EU-wide stress test does not contain a pass fail threshold. Instead it is designed to support ongoing supervisory efforts to maintain the process of repair of the EU banking sector.

The stress test will therefore be an important input into the supervisory review process in 2016.

As the stress test has a range of constraints designed to ensure comparability and consistency, supervisors will assess mitigating management actions before deciding on the appropriate supervisory action, of which a wide range may be employed. The focus in 2016 will, however, be on setting Pillar 2 Guidance to banks to maintain capital that can support the process of repair and lending into the real economy. Although pillar 2 Guidance is not a legal minimum, and does not impact the threshold for the Maximum Distributable Amount, banks are expected to follow guidance in normal circumstances.

Acting as a central data hub for the entire EU, the EBA is publishing both aggregate results of the EU-wide exercise and granular data for each bank, including detailed information at both the starting and end point of the exercise, under the baseline and the adverse scenarios.

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The full analysis is shown below (link)