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    ECB Examines Resilience of Banking Sector to Stress Caused by Pandemic

    July 28, 2020

    ECB published the aggregate results of its vulnerability analysis of banks directly supervised within the Single Supervisory Mechanism. The exercise assessed how the economic shock caused by the COVID-19 outbreak would impact 86 euro area banks and aimed to identify potential vulnerabilities in the banking sector over a three-year horizon. Overall, the results show that the euro area banking sector can withstand the pandemic-induced stress but, if the situation worsens, depletion of bank capital would be material. ECB published a presentation highlighting that the banks’ use of capital buffers leads to better economic outcomes. Additionally, an article from Andrea Enria, Chair of the Supervisory Board of ECB, explains the ECB assessment of the results of the vulnerability analysis, along with the rationale behind the package of measures resulting from the vulnerability analysis.

    The vulnerability analysis focused on two scenarios set out in the June 2020 ECB staff macroeconomic projections: a central scenario and a severe scenario. These scenarios include, to a large extent, the impact of the monetary, supervisory, and fiscal relief measures taken in response to the COVID-19 crisis. These include, among others, national job protection schemes, other fiscal support measures, credit guarantees, capital and operational relief measures by ECB Banking Supervision, and the recent Europe-wide measures to provide relief under some of the provisions of the Capital Requirements Regulation. The analysis also reports results under the baseline scenario published by EBA for the EU-wide 2020 stress test. As this scenario was defined before the COVID-19 outbreak, it provides a benchmark to assess the impact of the pandemic on banks. Considering the extraordinary current circumstances and to avoid subjecting banks to additional operational burden, ECB used already available data for this exercise, including regular supervisory reporting.

    The central scenario already foresees a harsh recession and is the one most likely to materialize according to ECB staff. In the central scenario, banks’ average Common Equity Tier 1 (CET1) ratio, a key indicator of financial soundness, deteriorated only by 1.9 percentage points to 12.6% from 14.5%. As a result, banks could continue fulfilling their role of lending to the economy. Under this scenario, by the end of 2022 aggregate capital depletion for the euro area banking sector will be 1.9%, reducing the average Common Equity Tier 1 (CET1) capital from 14.5% to 12.6%. Most banks would reach maximum capital depletion in 2022. Under this central scenario, the opinion is that the euro area banking sector will remain, in aggregate, well-capitalized and can continue to fulfill its core function of lending to the real economy.

    The severe scenario represents a more adverse, but still plausible development of the crisis. In the severe scenario, banks’ average CET1 is depleted by 5.7 percentage points to 8.8% from 14.5%. The key drivers of capital depletion are impaired credit exposures, market risk losses, and lower profitability. As expected, the most profitable banks saw smaller declines in their CET1 ratios. This shows that banks that have strengthened their profitability through efficiency enhancing measures can also benefit from greater resilience in times of stress. In this scenario, several banks would need to take action to maintain compliance with their minimum capital requirements, but the overall shortfall would remain contained. The results of this analysis show the positive impact of the strengthened capital position of banks in recent years as a result of the post financial crisis regulatory reforms, according to Andrea Enria of ECB. "However, if the situation worsens along the lines of the severe scenario, authorities must stand ready to implement further measures to prevent a simultaneous deleveraging by banks, which could deepen the recession and severely hit their asset quality and capital positions.”

    The vulnerability analysis represents a useful tool to gauge the overall resilience of the euro area banking sector. Individual bank results have not been discussed with credit institutions and will be used in the supervisory review and evaluation process (SREP) in a qualitative manner. The results will also help supervisors to challenge banks’ capital projections, foster consistency in the assessment of risks, and promote prudent provisioning policies.

     

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    Keywords: Europe, EU, Banking, COVID-19, Vulnerability Analysis, Regulatory Capital, Central Scenario, Severe Scenario, CRR, Basel, SREP, SSM, ECB

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