EU Stress Test - EU Banking Sector Requires Comprehensive Recapitalisation

The European banking sector requires a comprehensive recapitalisation of its banks in order to withstand another potential crisis. Those banks in need of recapitalisation are not only from peripheral countries of the eurozone such as Italy and Spain, but also from countries such as Germany and France. If the market index were to drop by 40 per cent over a six-month period, the estimated capital shortfalls of European banks would amount to up to €882 billion. Banks are likely to require public backstops in such a scenario.

These are the key results of a stress test scenario designed by  the Centre for European Economic Research (ZEW), Mannheim, in collaboration with the New York University Stern School of Business and the University of Lausanne.

The scenario is based on data by the European Banking Authority (EBA), which is due to publish the results of its own test today. The EBA stress test consists of 53 European banks, which comprise about 70 per cent of the banking sector, and of which 34 are publicly listed. The banks in this sample represent about €27 trillion in total assets. The total market capitalisation of the 34 publicly listed banks is €693 billion, the average market equity / assets ratio is 4.4 per cent.

On the basis of these figures, the researchers compared the market data as of November 2014 – after the European Central Bank's (ECB) stress test and shortly before the start of the Banking Union – to market data up until June 2016. In the end, the size of capital shortfalls of banks across EU countries was estimated in case of a systemic financial crisis.

"Banks lost on average one third of their market value"

"Since November 2014, the banks included in the stress test lost on average one third of their market value," says Professor Sascha Steffen, head of the ZEW Research Department "International Finance and Financial Management" and co-author of the study. The banks with the largest declines in market capitalisation are from Germany (49.4 per cent), Italy (47 per cent) and Spain (41.7 per cent).

On average, the capital shortfalls in a crisis scenario increased by 35 per cent, from €655 billion to €882 billion, for the period considered in the test. The banks with the largest percentage increase in systemic risk are from Spain, with an increase in capital shortfalls of 110 per cent, followed by Ireland (89.2 per cent), the UK (73.9 per cent) and Sweden (71.2 per cent). Italian banks' shortfall increased by 29.2 per cent, while that of German banks rose by about 8 per cent.

Capital shortfalls of 2014 still have to be dealt with

"Our results suggest that the European banking sector requires a comprehensive recapitalisation across almost all countries, including Germany," says Sascha Steffen. The results also suggest that capital shortfalls which were revealed in the ECB assessment in 2014 have not yet been dealt with. "Those banks that had large shortfalls two years ago still have capital shortfalls today."

Steffen and his co-authors suggest that the bank's capital needs could be remedied using common equity issuance or haircuts on subordinated creditors. However, extra public resources would be necessary. "The banking sectors in Germany, France, and Italy are likely to require public backstops to cover their deficits," explains Sascha Steffen.

Download the study at: www.sascha-steffen.de

For more information please contact

Professor Sascha Steffen, Phone +49(0)621/1235-140, E-mail steffen@zew.de