Stress test shows euro area banking sector could withstand severe economic downturn

The ECB released the 2023 stress test results for the euro area banking system, assessing its ability to withstand a severe economic downturn. Two stress test exercises were conducted for significant institutions in the region. 57 institutions were part of the EU-wide stress test coordinated by the EBA and the ECB, while 41 institutions participated in the parallel stress test conducted solely by the ECB.
The stress test evaluated how banks would perform under a hypothetical adverse economic scenario, featuring prolonged low growth, high inflation, and elevated interest rates. The results were not pass-or-fail but rather fed into ongoing supervisory dialogues to address any shortcomings. The stress test used 2022 year-end data and examined each bank’s capital position over the next three years under both the baseline and adverse scenarios, providing a common framework to assess the resilience of euro area banks to country-specific shocks.
The adverse scenario included rising interest rates and stagflation, posing challenges to banks‘ capital positions. However, the stress test demonstrated that the euro area banking sector remained overall resilient, with a depletion in the system-level CET1 ratio amounting to around 4.8 to 5.0 percentage points under the adverse scenario.
Credit and market risk losses, along with increased administrative expenses, drove the overall depletion. While some banks faced dividend payment restrictions and capital shortfalls, the stress test did not trigger immediate recapitalization actions; instead, the results informed the SREP.
The stress test also revealed qualitative findings, indicating risk data aggregation issues and deficiencies in credit risk modeling for some institutions. These outcomes would influence the determination of P2R and P2G in the context of the SREP.
Moreover, the stress test aimed to strengthen market discipline by disclosing bank-level results, allowing market participants to compare how common shocks affected banks‘ balance sheets. However, supervisory stress tests were not substitutes for banks‘ internal stress tests, tailored to their specific risk profiles and vulnerabilities.
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The ECB also publised an online FAQ supplementing the above stress test report. We would like to present the original questions together with a short summary of the corresponding answers:
What’s the 2023 EU-wide stress test about? What is its aim?
The 2023 EU-wide stress test analyzes how a bank’s capital position will develop over three years (from year-end 2022 to the end of 2025) under baseline and adverse scenarios. Its aim is to assess the resilience of EU banks to country-specific economic shocks and provide a common analytical framework for supervisors, banks, and market participants to compare and evaluate the banks‘ resilience.
How are the samples of euro area banks in the EU-wide stress test and the parallel ECB stress test selected?
The EU-wide stress test selects banks to cover around 75% of banking assets in the euro area. Banks with at least €30 billion in assets at the time of sample selection are included. However, banks with specific business models that are not suitable for the EU-wide stress test methodology might be excluded. In 2023, a total of 57 euro area banks under direct ECB supervision were included in the EBA sample. Smaller directly supervised banks outside this sample undergo a parallel ECB stress test (41 banks).
What information is made available on the results?
EBA publishes granular results for individual banks participating in the EU-wide stress test. For banks in the parallel SSM stress test, the ECB publishes aggregate results and selected bank-specific information, following the principle of proportionality for smaller banks.
What will the ECB do with banks that have a (severe) shortfall in the adverse scenario?
The stress test is not a „pass-or-fail“ exercise. Instead, the results serve as key inputs into the SREP decisions for each bank. Banks with (severe) capital depletion in the adverse scenario can expect a higher P2G than those with better results. JSTs use this information to follow up with targeted supervisory initiatives and measures to address specific risks.
How are stress test results integrated into the SREP?
Stress test results influence the SREP both quantitatively and qualitatively:
– Quantitative outcomes are used to determine the P2G using a two-step approach, considering the maximum capital depletion and expert judgement. Additionally, the leverage ratio P2G is applied for certain institutions.
– Qualitative outcomes assess a bank’s internal governance, risk management, data timeliness, accuracy, and responsiveness. This influences the calculation of the P2R and involves a scoring system based on measurable criteria.