Banking supervision is not satisfied with the major banks in the euro zone. Although the volume of problem loans fell significantly, the majority of the institutions do not even earn their cost of capital. Six banks also missed capital requirements in the second pillar and have to rework as soon as possible.
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The ECB is not satisfied with numerous large banks.
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The largest and most important banks in the euro zone are now continuously monitored and monitored by the European Central Bank (ECB). During the review, the so-called Supervisory Review and Evaluation Process (SREP), 6 out of 109 banks did not meet certain minimum recommendations of the supervisory authority for 2019, namely the pillar 2 recommendations (PillG 2). The institutions concerned, whose names are not mentioned, have therefore been requested by the ECB to take corrective measures. Four banks are said to have got their problems under control. With regard to capital, the ECB differentiates between minimum requirements (Pillar 1, including hard equity) and certain additional capital requirements (Pillar 2).
No institute reaches the top grade one
In the annual assessment, the banks can achieve a rating from one (best grade) to four (worst grade). Not one bank made it to 2019. The percentage of banks with a grade of two also decreased from 52 to 49%. At the same time, the share of institutes with an overall grade of three increased from 38 to 43%. The group of banks with the worst value four decreased accordingly from 10 to 8%. There is a positive development in the volume of so-called problem loans (non-performing loans, NPL). Five years ago, these were around 1 bio in the euro area. €, which resulted in an NPL ratio of 8%. By the end of September 2019, the value had dropped to € 543 billion, which now corresponds to a rate of 3.4%. The decrease in absolute volume compared to 2018 was only a good 6%.
The requirements and recommendations of the banking supervisory authority for hard equity (CET 1) in Pillar 1 remained unchanged in 2019 at 10.6% overall compared to the previous year. Accordingly, Andrea Enria, head of banking supervision at the ECB, was quoted as saying that he was largely satisfied with the overall level of capital at the major institutions that the ECB oversees. The ECB has been directly monitoring the largest banks in the euro area since November 2014, currently 117 institutions. The most recent survey generally provided the banks’ year-end values for 2018. The supervisory recommendations apply to 2020.
Hard equity (including CET 1) is the highest quality capital of a bank, which essentially consists of share capital. In addition, the ECB has requirements for capital in Pillar 2 (Pillar 2 Requirements, P2R) and gives banks non-binding recommendations for additional capital in Pillar 2 (Pillar 2 Guidance, P2G). The requirements (P2R), which are set by the supervision for the individual banks, remain unchanged at an additional average of 2.1%. The same applies to the recommendations (P2G) of Pillar 2 with an average of 1.5%. The recommendations are officially non-binding, but it is a top priority for every institute to comply as quickly as possible.
At 3% or more, the ECB tends to place the highest demands on additional capital, particularly on Greek and other primarily southern European institutions. Deutsche Bank has 2.5%, Commerzbank 2%, BNP Paribas 1.25%, Société Générale 1.75% and Unicredit also 1.75%.
The majority of banks do not earn the cost of capital
As part of the SREP process, banking supervision evaluates four core elements of each institution: firstly, the sustainability and sustainability of the business model, secondly, the adequacy of internal governance and risk management, thirdly, capital risks (including credit risk, market risk, interest rate risk and operational risks) and fourthly, liquidity and refinancing risks. The supervisory authorities found weaknesses this year in particular when assessing the business model and internal governance. Some banks also experienced significant losses, primarily due to behavioral risk events. 24% of banks also have problems with internal controls and 19% have problems with data reporting and risk infrastructure.
When reviewing the business models, the ECB found that most major institutions’ earnings are below the cost of capital. In the long term, this is unacceptable for a business model. The situation is also likely to be strongly related to the environment of extremely low interest rates and the so-called penalty rates for banks that they have to pay if they park money with the ECB overnight. The poor earnings have a significant impact on banks’ ability to generate capital. In terms of governance, on the other hand, the values have deteriorated overall in recent years. Three out of four institutes only achieved a value of three. In response to the overall poorer ratings, the supervisory authority wants to examine the sustainability of the business models and encourage banks to improve the effectiveness of their management bodies and to strengthen internal controls and risk management.
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