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…
Resource:
