Grim scenario for bank stress tests, says EU watchdog

European Banking Authority headquarters in London. [EBA]

The European Banking Authority has launched its third wave of stress tests conducted on 48 European banks. EURACTIV’s partner La Tribune reports.

The stress test, an ordeal dreaded by EU banks, is a resistance test meant to evaluate the resilience of banks to economic shocks. The European Banking Authority (EBA), whose headquarters will soon move to Paris from London, revealed how the risks have developed, describing it as “the most severe scenario to date”, since the first edition back in 2014.

This grim scenario would be one or two consecutive years of recession in the European Union, in 2018 (-1,2%) and in 2019 (-2,2%), followed by a modest rebound in 2020 (+0,7%). This would come down to a gap in the GDP of 8.3% in 2020 compared to the actual growth predictions in the EU, to a 3.3 point increase in the unemployment rate,  and a 27.7% drop in property prices compared to current estimates.

The severity of these assumptions can be placed between “the adverse and the severely adverse scenario” in comparison to the Comprehensive Capital Analysis and Review exercise done by the American FED, states the EBA.

The test will cover a sample of 48 banks representing 70% of banking assets in the eurozone, with the help of the European Central Bank (ECB). The results will then be published on 2 November 2018.

They will be used by the ECB in the SREP process [Supervisory Review and Evaluation Process] to find the minimum capital requirement for the banks it supervises.

The previous test, which took place in 2016, pointed out the fragility of the Italian bank Monte dei Paschi di Siena, which the Italian government bailed out last year.

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Repricing on global markets, public and private debt

The EBA has identified four systemic risks and assessed the most significant threats to the European banking sector. The danger is that they could follow each other and eventually lead to a snowball effect.

Above all, the biggest risk would be “a repricing of risk premiums in global financial markets,” warned the EBA, as geopolitical tensions or changes in investors’ expectations could lead to a fall in asset prices and a steepening of yield curves, therefore tighter financial conditions.

Then a decline in economic activity and a rise in unemployment on an already low profitability rate in banks of certain countries (Italy comes to mind).

The third risk is the eventual “re-emergence of public and private debt sustainability concerns” because of a rise in interest rates.

Lastly, “liquidity risks in the non-bank financial sector”, if investment, pension, and insurance funds were forced to sell assets this would amplify the drop in value of these assets and contaminate the whole system.

The EBA, which will move its headquarters from London to Paris because of Brexit, hardly mentions the withdrawal of the UK from the EU, and instead says that its dark scenario “encompasses a wide range of macroeconomic risks that could be associated with Brexit”, particularly on the outcomes of the UK’s trading relationship with the EU.