EBA releases stress test results; to review comparability of risk-weighted assets

7 May
risk-weighted assets

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The European Banking Association released the results of its capital and balance sheet stress test on Tuesday. Most findings about the integrity of the sampled banks’ holdings were positive, and indicated a move away from risk-weighted assets (RWAs), particularly credit risk.

The 2014 Q1 dashboard reports that banks with a coverage ratio of over 50% now hold almost 49% of total assets in the sample, relatively unchanged from earlier assessments; banks with a poor coverage ratio (under 25%) still account for roughly 13% of total assets reviewed.

Useful tools included in the reports were a heat map of Key Risk Indicators, and a summary of the directional trends in areas such as credit risk, market risk, operational risk, concentration risk, reputational and legal, and profitability. Margins were found to have suffered, partly due to legal and redress costs and smaller gains from lower interest rates. It cited heightened geopolitical tensions in Russia and Ukraine as contributing to heightened volatility, in addition to speculation over extra-European nations’ Central Bank policy, particularly that of the US Federal Reserve.

The integrity of banks’ loan portfolios continued to decline: the ratio of impaired loans and past due (over 90 days) loans to total loans peaked to 6.8%. However, the weighted average of delinquent loans was up by just 0.2 percentage points, so the EBA concluded “this trend is mainly driven by the decrease of the denominator since the amount of impaired loans and past due… loans has remained fairly stable over the last quarters.”

Overall, the weighted average of debt-to-equity ratio has sagged from 17 to 16.5, the lowest level in the last four years. Customer deposits now comprise around 48% of total liabilities, while holdings of credit and other liabilities with a greater risk profile have tapered.

The EBA has announced it will launch a review into the comparability of RWAs, prompted by the wide distribution of estimates as to the risk profile. This is assessed predominantly through an internal ratings-based IRB approach: a study into asset distribution, released December 2013, showed an IRB was used to assess 71% of risk-weighted assets, compared to 29% which used a Standardised Approach.

Each bank’s individual IRB approach involves its unilaterally calculating three input risk parameters: the probability of default (PD), the loss given default (LGD) and the exposure at default (EAD).

The regulator explained: “While differences in risk parameters and capital requirements between banks are not a sign of inconsistency per se, a substantial divergence may signal that the methodologies used for estimating risk parameters require, in some cases, further analysis.”

In its summary of the components of Pillar 1 bank risk, the EBA stated that asset quality would remain an issue of concern, but that “Upcoming review of assets should boost clarity on problem loans and level of impairments/provisions.”

It has not yet gone so far as to state the Committee of European Banking Supervisors (CEBS) EBA Guidelines might need updating.

 

 

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