A new audit report published this week by the European Court of Auditors (ECA) concludes that the bank stress test carried out last year by the European Banking Authority (EBA) should have been more demanding in testing the banks´ resilience to systemic risks across the EU. The simulated shocks were actually milder than those experienced during the 2008 financial crisis.
The report can be read against the backdrop of new risks for an economic downturn in the near future. In its Summer 2019 outlook for the European economy, the European Commission wrote that the economy is clouded by external factors, including global trade tensions and significant policy uncertainty (“no deal” Brexit).
The EBA was established in 2010, with one of its tasks being to run EU-wide bank stress tests. The stress test last year included 48 banks in 15 countries. The adverse scenario was a negative three-year projection of macroeconomic conditions including GDP, unemployment, housing prices and interest rates.
“In our audit of the EBA, we checked for the first time how the EU-wide stress tests were designed, conducted and supervised. In brief, we checked whether they were fit for purpose,” said Neven Mates, the Member of the European Court of Auditors responsible for the report, to The Brussels Times (11 July).
Mates, an economist from Croatia, says that the ECA has not analysed the latest economic forecast and is not in a position to comment on it but his audit conclusions do not bode well for the European bank system if a new crisis should erupt.
“European banks should have been tested against more severe financial shocks. Moreover, key decisions at the EBA are taken by representatives of national supervisors and an EU-wide perspective was not sufficiently taken into account in the way the test was designed and conducted.”
For this reason, the mild impact of the shocks on certain banks may not have been due to the good health of these banks, but to the low level of stress applied.
In selecting the banks for its EU-wide stress test, EBA’s main criterion was the amount of assets. However, banks which had recently been bailed out were excluded. Moreover, the sample excluded banks from some countries where banks have considerable exposure to their own sovereign bonds or have a high concentration of non-performing loans.
The EBA had very limited staff for the 2018 stress test performance – around seven full time equivalents.
How does ECA explain that EBA did not sample the banks on the basis of a risk analysis? Mates replies that the EBA argued that there should be a “neutral selection of banks without any a priori belief” and that “there could be selection bias with supervisors selecting only ‘weaker’ banks”. ECA does not agree.
“Considering that stress tests should, firstly, evaluate the potential for systemic risk to increase in situations of stress and, secondly, identify those institutions that may themselves pose a systemic risk, in particular in times of stress, our view is that the EBA should also take risk into account when selecting the banks,” Mates underlines.
ECA recommends that the European Commission should review EBAs governance arrangements and possibly add human resources to it. Asked if the Commission has a mandate to do that, Mates replies that the Commission is authorised to propose changes to the regulation of the European supervisory authorities.
”It did so in 2017 and we recommend that it should address this issue again in the context of the next review of the EBA regulation. With regard to human resources, the procedure is established in the EBA Regulation and involves a role for the Commission.”
In another audit report from December 2017, ECA examined The Single Resolution Board (SRB), another component of the European Banking Union, and found that its work on reconstructing failing banks was still work in progress. The auditors issued a number of recommendations relating to SRB´s legislative framework, resolution plans, and staffing.
Asked if the recommendations have been implemented, ECA replied that, ”It is yet too early to say whether the recommendations from our performance audit of the SRB have been put into practice, as we are currently looking at their implementation as part of the follow-up.”