As anticipated the mostly positive results of the 2016 EBA stress tests show visibly strengthened EU banks’ capital position; however main emerging structural weakness remains untested. Referring to the EBA stress test results announced last Friday, Scope Ratings noted that as anticipated on aggregate they highlighted a much improved capital position for the large EU bank sector.
It was no surprise that in the group of 51 banks that were stress tested Monte di Paschi (unrated) emerged as the only major outlier with a negative CET1 in the adverse scenario. “To an extent, the EBA stress test’s surprise was that there were no surprises,” notes Sam Theodore, head of Scope’s bank ratings team, adding that in his view the regulators delivered solid reassurance to the market that the EU bank sector is in much better shape than many were fearing. New issuance from the sector should follow, especially from September onward, concentrated in AT1 and Tier 2 as well as MREL/TLAC-eligible senior unsecured debt.
One major positive takeaway of the EBA stress test is that it brings welcome transparency for market participants and the banking industry on the criteria and metrics used by supervisors in their SREP work. In the past Scope has highlighted the importance of relevant and consistent supervisory transparency and communication for preserving favourable market sentiment with respect to European banks. In this context, the rating agency pointed again to the very positive contribution of the EBA in its few years of existence to improving the quality and amount of pertinent disclosure of bank-related data for investors and other market participants – who ultimately are the ones providing both funding and equity to the banking sector.
That being said, however, Scope considers that the main challenge facing the European banking industry going forward remains untested by regulators, at least publicly. To some extent, stress testing banks’ capital in relation to (legacy) asset quality and misconduct is projecting forward yesterday’s problems. A major challenge for the banking industry, especially in Europe, will be revenue generation at a level preserving investor interest and especially justifying the cost base.
The new credit culture: less reliance on borrowing from banks
In this respect, Scope cautions that European banks will continue to operate in a low-to-negative rate environment for some time, thus challenging their net interest margins (in general banks do well in a moderately rising rate environment, at least as long as the credit quality of their borrowers does not deteriorate). More importantly, the new credit culture that emerged after the crisis, among both businesses and individuals, is one of less reliance on borrowing from banks. Scope does not expect this behavioural aspect to change very soon, especially in continental Europe.
At the same time, while fees and commissions were an important component of earnings for the larger and more diversified banks, they are now coming under pressure due to secular adjustments in the asset management industry (impact of technology, changing client behaviour, tougher competition in an industry which is plateauing). And while during the financial crisis a good performance in emerging markets was sustaining revenue generation for large cross-border European banking groups, this is no longer universally the case.
In Scope’s view there is significant excess capacity in the European banking industry – not only in wholesale and investment banking (especially secondary markets), but in retail and commercial banking as well – which in the upcoming years will need to be addressed. Many large banks are engaged in reducing their branch capacity and this effort will continue and most probably intensify. In this respect, the agency noted that future regulatory stress tests addressing this emerging structural challenge could be appreciated by market participants. Scope concluded by stating that the stress test results in and of themselves should not be leading to any changes in the rating or outlook of the banks it covers publicly.
