123 banking groups and EUR 28,000 billion of assets reviewed – these are some of the key figures of the European Banking Authority’s (EBA) asset quality review and stress testing. 18% of performing loans scrutinized were reclassified to non-performing and an aggregate capital shortfall of EUR 24.6 billion arose.
Consequences for financial institutions in Switzerland?
Although Swiss banks were not in scope of the assessment, they should consider the results as these will drive the regulatory agenda in Europe. The assessment was of unprecedented rigor. The regulators are now calling into question whether procedures and policies with respect to credit risk management and loan impairment are appropriate. Interest rates that will most likely rise in the near future, as well as the declining real estate prices coupled with uncertain economic growth are sufficient reasons to re-examine whether it might not also be a good idea to introduce stress testing here. Against this background, institutions should ask themselves:
- Are assumptions underlying the stress test sufficiently severe, and do they take into account that other financial institutions may be facing stress simultaneously?
- Is the test conducted on disaggregated portfolio levels with homogenous risk profiles?
- Do tests occur frequently enough, responding to changes in the relevant environments? Could tests be carried out at short notice after ad-hoc requests?
- How efficient is the process? Do manual interfaces and edits of data represent hindrances to timely stress testing?
- Is the personnel involved sufficiently knowledgeable and experienced for the purpose of interpreting results? Is management taking the necessary actions, such as revisiting the new loans policy and market exposures?
- Would the testing approach withstand external scrutiny, and does it follow best practices of peers?
- Is capital allocated to the loan portfolio commensurate to credit risk exposures?
Supervisors in the EU have begun to put pressure on banks to align loan loss provisioning policies with current ECB expectations. This also impacts Swiss banks as market participants expect transparency and comparability.
In terms of business development, increased capital requirements may not only force institutions to get rid of higher risk assets, but may cause them to rethink their overall exposure. This creates, for solvent financial institutions, opportunities to acquire loan portfolios in other markets.
From a regulatory perspective, embedding stress testing into on-going risk management practices and setting up loan loss provisions with a more conservative approach is becoming more important.
The comprehensive assessment is not considered a one-off exercise, but rather a recurring supervisory tool. This also influences FINMA’s agenda, in particular given the macroeconomic developments of increased credit risks, which traditionally have often caused global financial crises.