Europe’s Custodians Pass ECB Stress Tests, Some Say Process Is Flawed

Europe’s custodian banks have passed the stress tests led by the European Central Bank (ECB) after many registered better than expected levels of capital.

Among these banks include the Belgium-branch of BNY Mellon, Luxembourg-based Clearstream Banking, Soceite Generale and BNP Paribas.

The assessments included an examination of the balance sheet and a verification of equity capital coverage levels.

Clearstream managed to achieve a core Tier 1-quota of close to 20%, the bank stated, while Societe Generale and BNP Paribas reported a common equity Tier 1 ratio of 10.6% and 10.3% respectively, well above the minimum of 5.5% defined by the ECB for the exercise.

The stress tests come as the Eurozone prepares for the implementation of the “Single Supervisory Mechanism” (or the banking union) on November 4, which will make the ECB the highest regulatory authority for banks in the region.

“This is an unprecedented exercise in transparency, which lays the foundation for the new single supervisory mechanism in Europe and will help increase confidence in the sector,” says Frederic Oudea, chairman and CEO, Societe Generale.

Out of 123 Eurozone banks and banking groups only 24 failed, with around 14 now under review.

Banks deemed having too little capital to protect against risk have two weeks to file pans for raising more, and will then have up to an additional nine months to meet the minimum threshold.

A flawed process
Despite the merits, some think the stress tests have serious flaws.

“The regulator focusses on capital strength and liquidity and what is missing is the strategic element,” says Sven Ludwig, senior vice president, risk and analytics EMEA at SunGard. “Struggling banks can find themselves locked into a prison of liquidity and capital ratios. Capital, liquidity and profitability form a triangle which defines the health of a bank. Europe’s banks in aggregate have suffered seven years of low profitability. Without profits, banks cannot rebuild their capital base and will slowly fail.”

Plus, consultancy Catalyst takes issue with the timeliness of the data.

“Good stress testing data, and indeed all risk data, needs to be timely, to enable good decision-making,” says Catalyst’s Damon Batten, an expert in derivatives market reform and regulation. “Unfortunately, the balance sheet data on which the ECB exercise is based is far from timely. The massive 10 month gap between the balance sheet used and the publication date is indefensible, if these results are supposed to offer an accurate view of either current health or future stability.”

SunGard adds that there could be a problem with misalignments of incentives and regulation, such as between the capital ratio weightings for sovereign bonds and the attempts to de-risk banks through the stress test process. “It is inherently contradictory that sovereign debt of, say, Greece—after everything that has happened—has still a risk weighed asset designation of zero, in other words such a bond is assumed to be riskless,” says Ludwig. “Politicians are pushing banks to invest in sovereign debt yet complain when they subsequently fail the stress test.”

On the positive side, though, the stress tests give banks a better view of their risks.

“Much of the risk management thinking is very static in nature whereas in most cases risk comes from changes in the market or customer behaviour,” says Markus Gujer, SunGard’s head of Banking Risk. “The stress testing process has shown banks where they are vulnerable to change and has enabled them to stop looking at risk through the rear view mirror. The board and risk managers now have to think beyond merely meeting capital thresholds. Meeting capital thresholds is no business model, it does not generate profits and does not make a bank survive.”