Europe’s banks would be able to absorb a very severe economic crisis marked by a sharp drop in their financial reserves, according to the results of a stress test conducted by the European Banking Authority (EBA).
In the worst-case scenario used in the test, a “very severe” crisis over three years, the European banking sector would suffer a capital depletion of 265 billion euros by the year 2023, the EBA said in a press release issued on Friday.
That scenario covers the effects of a prolonged health crisis due to the coronavirus pandemic coupled with an environment of lower rates over a longer period, with the year 2020 – marked by an already deteriorating economic environment – as baseline year.
Such a situation would see the gross domestic product (GDP) of the European Union fall by over 3% in three years, with a generalised downturn in all countries.
As a result, the European banking sector’s common equity Tier 1 (CET1) ratio, a key indicator of financial solidity, would decrease from 15% to about 10%, a level generally considered acceptable by the EBA after three years of stress.
However, that percentage is an average. All told, 20 banks out of the 50 covered in the EBA stress test would fall below the 10% benchmark after three years, according to data from the survey, conducted in conjunction with the European Central Bank.
Monte dei Paschi di Siena, an Italian bank that has been struggling for a long time and is in the process of being bought out by UniCrédit, would even sink to a CET1 of -0.10%.
Some of the other banks would suffer heavy losses, such as Germany’s Deutsche Bank, which would post a loss of over 10 billion euros at the end of 2021, French bank BNP Paribas, a projected loss of 11 billion euros, and Santander of Spain, a loss of over 5 billion.
The overall figures mask major differences between banks: capital depletion appears to be greater in establishments with little international diversification and those with the lowest interest earnings, according to the EBA.
As in previous tests, credit losses account for the bulk of the capital depletion. The heaviest losses were in France, followed closely by Germany and Italy.
In Belgium, the EBA looked at KBC and Belfius. In an unfavourable scenario, their CET1 ratios in 2023 would be 14.1% and 13.7% respectively, much higher than the average rate projected for the euro zone in 2023, which is 9.7%.
Both banks have an above-average baseline among the major euro zone banks covered by the test.
At the beginning of the test – the end of 2020 – the KBC had a CET1 ratio of 17.6% and Belfius, 16.4%. Both values are way above the average of 14.7% for the euro zone banks covered by the test, Belgium’s Banque nationale (BNB) noted in a press release.
“The best starting points for these banks, and their performance at this year’s stress test, reflect, at least partly, the persistence of the adjustments they have carried out in the last few years, including strengthening their common equity situation, controlling their operational spending, and provisioning efforts made during the Covid-19 crisis,” the BNB said.
Welcoming this result, Belfius said it confirmed its “robust solvency, solid resistance to adversity and the relevance of healthy financial and risk management, cornerstone of its long-term diversification strategy.”
ING Belgique and BNP Paribas Fortis participated in the EBA test through their parent companies.
The test was to have been launched in 2020 but was postponed to 2021 due to the global COVID-19 pandemic. Launched in January, it covers 50 banks in 15 European countries, representing 70% of assets in the European banking sector.