The results of the European Banking Authority (EBA) stress tests are in and, if you haven’t already, it’s time to start thinking about what they might mean for banks.
The results of this most recent stress test are an improvement on the previous round, but many observers are flagging their concern over the impact of further deterioration of EU Sovereign debt exposures on banks’ balance sheets. The EBA will soon be releasing its recommendations for those banks that fell short of the 5% Core Tier 1 (CT1) benchmark, sending a strong signal that capital bases must be strengthened by the end of 2011; we’re expecting follow-on reports to the market in February and June 2012.
As the market digests the significance of the stress test results, many firms will be looking at how the next wave of regulation will affect their balance sheet strength. For most banks, Basel 3 / CRD IV will increase capital requirements and introduce a number of new capital buffers – all designed to further increase capital adequacy. As is often the case with emerging regulation, the devil is in the detail of how these capital buffers will work in practice. This is causing a headache for internationally active banks that could be subject to up to four separate buffers: the capital conservation buffer, the countercyclical capital buffer, a SIB (Systemically Important Bank) buffer and the existing Pillar 2 capital planning buffer. You can imagine the additional burden for firms who will have to set-up mechanisms to monitor separate triggers for each to avoid the restrictions or penalties which might be levied if breached. For a firm looking to retain control of its capital management activities, including dividend and bonus payments, the precise operation and interaction of these buffers is critical as the effect of building-up and drawing-down the buffers could vary significantly depending on the final text of the regulations.
While we await the final rules, we’ve seen prudent banks begin to develop models to allow them to analyse the impact of the buffers under varying scenarios which take into account different interpretations of the rules. This is a good start but the perennial challenge of data quality must be conquered if the models are to provide the granularity of forecasting required.
Post by James Nicholls on the 27th of July 2011
For more information on the EBA
stress test results, follow this link: http://stress-test.eba.europa.eu/
Baringa Partners’ Financial
Services Risk Management & Regulatory Compliance Practice specialises in
helping firms understand the implications of new regulation and implement
strategic change programmes to enhance risk management. To discuss how we could
help your firm, contact Gareth Campbell: Gareth.Campbell@baringa.com
