Will Europe’s Bank Stress Tests Lead To Fireworks?

This year’s European Banking Authority (EBA) stress test results are set to be released on July 29, which should be an important date in the calendar for financial analysts across Europe and the US.

However, as Bank of America writes in a research report issued to clients at the end of last week, this year’s stress test from the EBA was never designed to be challenging and could be somewhat of a non-event.

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Indeed, the 2016 EBA stress test does not include the “pass/fail” conclusion of prior tests. Nor is it widely assumed that banks will have to raise equity as a result of a poor grade. According to the EBA:

“The 2016 EU-wide stress test does not contain a pass fail threshold and instead is designed to be used as a crucial piece of information for SREP in 2016. The results will thus allow competent authorities to assess banks’ ability to meet applicable minimum and additional own funds requirements under stressed scenarios … [and] provide solid ground for discussions with individual banks to better understand (i) relevant mitigating management actions and (ii) how a bank’s capital position may be affected by the adverse economic conditions.

No pass/fail threshold has been included as the objective is to use the stress test as a supervisory tool, whose results will be discussed with individual banks in the SREP process, where mitigating actions may also be considered.”

Stress tests could lead to fireworks 

Having said all of the above, the EBA’s stress test results will be released into a jittery market on June 29. Large drawdowns in capital as a result of the tests may prove to be headline grabbing for some of the main banks and what many have been considering to be a non-event may have significant repercussions for many European banks.

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But while the results on June 29 may spark some debate, analysts at Bank of America write that the test results should be viewed with caution. The stressed scenarios have often been focused on a re-run of historical experience (2008) as a consequence, Ireland generally does poorly:

“As has been the case in previous tests, the stress tests apply relatively more severe GDP assumptions to smaller economies. Ireland is on the wrong side of this, Spain the right side. This reflects historical experience, particularly over 2008-11. Similarly, Central & Eastern European economies tend to be stressed more severely than those in the euro area. Counterintuitively, Sweden also is stressed severely, with a minus 13.5% deviation in GDP in the adverse case, compared with a euro area average of 6.8%.” – BoA on this year’s EBA stress tests.

Will Europe’s Bank Stress Tests Be A Non-Event?

Whether or not this is appropriate for the current environment remains up for debate.

Still, BoA goes on to note that a bank with a large stressed capital draw-down in the adverse case could be expected to have a higher Supervisory Review and Evaluation Process (SREP) requirement for 2017. So, even though many expect the June 29 stress test results released to be a non-event there may be some fireworks if systemically important banks are found to have a large stressed capital drawdown by the EBA.