European regulators to begin stress testing banks

Europe’s biggest banks face a stress test this year that will gauge their capacity to withstand economic contraction at home, shocks in major emerging markets and declines in property markets and commodities.

None of them will pass - or fail. The test has no pass mark to identify capital shortfalls, a break from previous practice, because banks have emerged from the financial crisis, the European Banking Authority said.

Supervisors such as the European Central Bank and the Bank of England will factor the results into their annual assessments of lenders. Both have said the industry is well capitalized and they won't be imposing significant new capital requirements.

The adverse scenario for this year’s health check, published on Wednesday by the London-based EBA, exposes banks to recessions in the European Union this year and next followed by anemic growth in 2018.

It assumes gross domestic product rising 3.4 per cent in China this year, compared with a baseline projection of 6.5 per cent.

In Russia and Brazil, 2016 GDP plunges 8.1 per cent and 5.9 per cent, respectively.

“These stress tests should have limited impact on the banks’ capital plans,” KBW bank analysts said in a research note after the EBA publication on Wednesday.

“These scenarios are not that far from the fears priced in today in bank valuations.”

Commodity prices also take a hit in the EBA’s adverse scenario, with oil prices down about 48 per cent this year from the baseline projection of about $54 a barrel.

Brent crude for April settlement lost as much as 56 cents, or 1.6 per cent, to $33.85 a barrel Thursday morning on the London-based ICE Futures Europe exchange. Prices remain about 44 per cent below baseline levels in 2017 and 2018 in the EBA test.

The scenario projects that long-term interest rates in the EU would be higher by 71 basis points in 2016, 80 basis points in 2017 and 68 basis points in 2018.

Meanwhile, the test includes an overall decline of 6 percent in house prices, a supplemental shock of 7.5 per cent affecting all EU countries and additional house-price declines in Denmark, Ireland and Slovakia.

In 2014, to pass a baseline scenario, banks had to maintain a ratio of capital to risk-weighted assets of 8 per cent.