Thursday, November 14, 2013

ECB Note on the comprehensive assessment of the European banking system – Searching for 12 bn market capitalization!

On October 23, 2013, the ECB has published a note on its next year’s assessment of European banks. This has had a huge effect on European banks’ stock prices. They lost 12 bn € market capitalization, representing an average 2.7 %.





Is the ECB paper worth that much money? Let’s have a closer look.


Rationale

With its assessment, the ECB wants to

  • enhance the transparency (namely the quality of the available information) of European banks’ condition;
  • repair, if and where needed, the condition of banks by taking corrective action;
  • build confidence in the soundness and trustworthiness of the European banking sector.


Process and timing

“The ECB will conduct the exercise, detailing its design and strategy, monitoring its execution in close cooperation with the NCAs [national competent authorities], performing quality assurance on an ongoing basis, collecting and consolidating the results and finalizing and disclosing the overall asset.”

The information content of this statement is almost 0 but we have gained 4 lines of reading the ECB note (and this post)!

After reading that Oliver Wyman will assist the ECB, in addition to national regulators, we learn that the assessment can be broken down into three sections:

  • Supervisory risk assessment: This addresses “key risks in the banks’ balance sheets, including liquidity, leverage, and funding”. The ECB will do quantitative and qualitative analysis based on backward and forward-looking information”.
  • Asset quality review: The review will be done on the basis of banks’ December 31, 2013 balance sheets. All asset classes and types of exposures are verified and, in addition, off-balance sheet assets included. More specifically the asset quality review will assess whether provisioning for credit exposures is adequate, determine whether the valuation of collateral for credit exposures is adequate, and analyze the valuation of complex instruments and high-risk assets on banks’ balance sheets. The three phases of the asset quality review are “portfolio selection (ensure that exposures with the highest risk are subject to in-depth review), execution (data integrity validation, sampling, on-site reviews of files, collateral valuation and recalculation of provisions and risk-weighted assets), and collation (final consistency exercise)”.
  • Stress test: The ECB will associate the EBA (European banking authority) in this exercise and “provide ad forward-looking view of banks’ shock-absorption capacity under stress.”

In terms of timing, the portfolio selection starts off in November 2013. The assessment shall be concluded by October 2014, prior to the ECB assuming its new supervisory task in November 2014.


Capital threshold

The comprehensive assessment applies an 8 % capital threshold. This means that risk-weighted assets should represent 8 % of Common Equity Tier 1 Capital. The 8 % figure breaks down in 4.5 % Common Equity Tier 1 ratio, 2.5 % capital conservation buffer, and a 1 % add-on for systemically relevant banks.


Follow up action

ECB’s assessment may lead to requirements for changes in bank’s provisions and capital. The bank might impose measures such as recapitalization, equity issuance, re-orientation of funding sources, and asset separation and sales.


List of banks

ECB writes, “The exercise covers 130 credit institutions in 18 member states, covering approximately 85 % of Euro area bank assets.”

A preliminary list of the banks covered by the ECB assessment is attached to the note. This is probably the most interesting part of the memo (at least for those institutions which did not expect to be selected).

In my view, the relevance of the ECB paper is pretty low. It seems that financial markets tend to over-react from time to time…


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