25 July 2016

Financial Times: Stress tests add pressure on European banks

But Europe’s banking cycle is not quite at the same point. EU stress tests, the results of which are due out on Friday, are focused on how short of capital the banks look in various scenarios — not how overcapitalised they are. Rather than championing the robustness of the system, investors fear the exercise will expose its weakness.

A new European banks research paper from analysts at Credit Suisse predicts that more than a quarter of the lenders it has studied will fall below minimum capital requirements in the stress test’s “adverse scenario”.

Two German lenders — Deutsche Bank and Commerzbank — look as vulnerable as the Italians.  Deutsche’s core equity tier one ratio declined from 11.1 per cent at the end of 2015 to 10.7 per cent by March. It is about €10bn short of what it will need to meet regulatory requirements within a couple of years. Few banks could raise equity efficiently, given market conditions. For Deutsche, as for many European banks, the fallback of generating capital through retained profits is also problematic.

As the bank has shrunk and interest margins have been squeezed, restructuring costs and litigation provisions have mounted. Earnings are on a declining trend. First-quarter profits were less than half the level of a year earlier. Second-quarter numbers this week look unlikely to buck the trend.

As the International Monetary Fund highlighted in a report last month, Deutsche is probably “the most important net contributor to systemic risks in the global banking system”.

But, unless something changes before Deutsche’s projected capital shortfall becomes pressing, it is hard to see a third way.

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