In EU stress tests, everyone’s a loser

European Union-wide stress tests deserve a 'Could do better'

Imagine an exam that can’t be failed, is designed to give some participants an easier ride, and doesn’t even include the whole class. Sounds like a waste of time, right? And yet the European Union-wide stress tests, the results of which were published on November 2, followed this exact blueprint.

Forty-eight banks participated, representing 70% of EU banking sector assets. But no lenders from the economically embattled nations of Cyprus, Greece, and Portugal featured. Nor did some of the most beleaguered banks of other nations, such as Italy’s Banca Monte dei Paschi di Siena.

No sanctions were applied to banks that didn’t perform well – partly because there was no pass/fail threshold. In fact, the way the European Banking Authority tells it, the tests were designed to help the examiners more than the examinees, by serving as an “important source of information” for the framing of supervisory review processes and Pillar 2 capital add-ons.

Yet by digging into the data, it’s easy to learn which banks are top of the class and which are due a big, red ‘F’.

Though no bank’s core capital breached regulatory minimums over the three-year stress period, UK banks Lloyds and Barclays, along with Italian lender Banco BPM, came closest. They would have performed worse, too, if not for transitional measures that reduced the capital-sapping effect of new accounting methodology IFRS 9, which came into force at the start of this year.

Barclays, Deutsche Bank, Banco BPM and two German landesbanks also fell below the regulatory minimum 3% leverage ratio under the stress scenario.

But these banks were always likely to have a rougher ride than some of their peers in other EU nations, because the tests assumed cumulative GDP growth over the three-year period of –3.3% in Germany and the UK, and –2.7% in Italy. That compares to just –1.5% for France and –0.2% for Ireland.  

Furthermore, hefty falls in residential and commercial real estate prices factored into the tests would naturally cause more damage to banks with large mortgage portfolios, such as UK lenders.

To summarise, the EU stress tests have no official winners or losers, are harder for some banks to do well in than others, and allow participants to employ transitional measures that make them appear stronger. It’s a wonder we can call them ‘tests’ at all.