➤ Increasing the scope of the stress tests would be too onerous and delay the publishing of the results, making them less valuable.
➤ Stress tests show European banks are resistant to severe scenarios.
➤ Taking the risk profiles of individual banks and regions into account in the future would make the results more useful.
Stress-testing European banks under additional scenarios would be impractical and offer limited value and insight, experts said during an S&P Global Market Intelligence and European Banking Federation webinar on Sept. 12.
The current tests are "already a big undertaking for banks, and especially the mega-sized banks because of their very complicated balance sheet," so subjecting them to additional scenarios would be overly onerous, said Salman Khan, director of product strategy within the financial institutions group at Market Intelligence.
In response to a question about how regulators, despite the stress tests, failed to recognize liquidity challenges earlier in 2023, Khan said that it was difficult to determine what sample size to use. Instead, it was important that stress tests focus on institutions that show the banking sector as a whole.
"As long as you feel your stress tests are giving you a financial systemwide view ... we're still on the right path, and we do not need to include such smaller institutions," said Khan.
The most recent European Banking Authority stress test, conducted on 70 banks in 16 EU and European Economic Area countries, showed that lenders were well positioned to handle more challenging conditions and had sufficient capital buffers in place. This was under an adverse scenario that factored in persistent and higher inflation, increasing interest rates and credit spreads, high unemployment, substantial declines in asset prices, and severe recessions globally.
Hospitality and construction posed the biggest risks to banks, the tests found, while US banks' European units showed strength.
This all indicated, Khan said, that the tests were meeting the objective of assessing the resilience of the banking sector, so an expansion would offer limited additional value.
Another problem with expanding the scope of the scenarios is that it would cause a delay in publishing the results.
Banks provided information to regulators in January, said Diego Maria Serra, senior manager of solvency at Banco Bilbao Vizcaya Argentaria SA, with the results only published at the end of July – a time frame during which a lot can happen.
"If we get three [or] four scenarios, or maybe even two, it will take even longer. Maybe we will see results a year after that. It wouldn't make any sense," he said. "There's a lot of burden in this exercise, a lot of questions from the [European Central Bank] when they are doing the quality assurance, and I don't see how [an expansion of the scenarios] would be even possible."
It would only be possible to look at multiple scenarios, or to include other banks, if regulators were to "lighten the exercise," said Marc Irubétagoyena, global head of stress testing at BNP Paribas SA.
Scenarios that examine more specific risk factors, idiosyncrasies of individual lenders and the regions they operated in, or that allow for consideration of management actions would be more useful, the panelists said.
What the test in its current form did show, however, was a banking system that was adaptable, Irubétagoyena said.
"I think it's more COVID and the credit crises that have shown that the banking sector is more resilient and is able to adapt quickly, and these stress tests are confirming that. Solvency ratios are quite close, on average, at the end of 2022 [versus] what we had in [the] previous stress test. The difference we have in this exercise is the profitability of banks is much improved ... and that's the first line of defense," Irubétagoyena said.
The bottom line, Market Intelligence's Khan said, was that the tests showed banks are sufficiently capitalized.
"I think it's a resistant banking sector, and very much feels like from this stress test results that we went through a COVID era and still passed with flying colors," Khan said.
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