Basel III EU Bank Monitoring Results Show Stronger Loss Buffers, a Credit Positive
On 13 September, the European Banking Authority (EBA) published Basel III monitoring results for European Union (EU) banks as of year-end 2015. The results show progress toward meeting Basel III capital requirements and a higher capacity to absorb losses in adverse operating conditions, both in terms of quality and quantity of the available capital, a credit positive. The results indicate that EU banks in 2015 were €5.3 billion short of meeting the Basel III fully phased-in minimum capital requirements due in 2019 for risk-based ratios such as common equity Tier 1 (CET 1), Tier 1 and total capital as well as the non-risk-based leverage ratio. The shortfall is substantially lower than the €29.2 billion gap in 2014. The Basel III monitoring report for the EU covers 227 banks in the region and supports the EBA’s 29 July stress test findings that a significant sample of EU banks (51 institutions) has sufficient capacity to handle adverse conditions.3 For the aggregate sample of banks, the EBA reported a fully phased-in CET 1 ratio of 12.7% as of year-end 2015, which compares to 12.6% for the EBA stress test sample. Internationally active (Group 1) banks improved their results to 12.4% in 2015, from 11.4% in 2014, and more domestically focused (Group 2) banks improved to 13.6% in 2015 from 12.4% in 2014. The report shows that the decline in CET 1 capital until the application of fully-phased-in definitions is larger for Group 1 banks at -4.7% than for large Group 2 banks (-3.5%) and small Group 2 banks (-1.8%). Similarly, Group 1 banks’ leverage ratios decline more after applying a fully phased-in definition than Group 2 banks’ leverage ratio. Nevertheless, all of the Group 1 banks are compliant with the targeted 3% leverage ratio and only nine Group 2 banks were non-compliant. However, Group 1 banks more frequently require additional Tier 1 capital to meet the 3% leverage ratio than they need to meet risk-based Tier 1 capital requirements. Consequently, Group 1 banks are more affected by the constraint imposed by the leverage ratio than Group 2 banks. For our rated EU banks, we find that all systemwide leverage ratios (as measured by Tier 1 capital to total assets4 ) are above the EBA’s recommended level of 3%, as shown in the exhibit below, which highlights the ten lowest leverage ratios at country level. Therefore, at a systemwide level, the ratio does not directly constrain banks’ capital levels. However, in banking systems in France, Sweden, Germany, the United Kingdom and Denmark, institutions lag or just meet the EBA’s reported total average of 4.9%. In these five systems, low leverage ratios primarily reflect considerably lower levels of asset risk because of benign operating environments, high exposure to local governments and public sector entities (thus low risk weights) and extensive use of internal models to derive risk weights. Although this reduces their risk-based capital requirements, as reflected by the less than 40% risk density (risk-weighted assets to total assets), banks in these systems are at the same time more affected by the constraint imposed by the leverage ratio because they have to hold higher Tier 1 capital in absolute terms to meet the leverage ratio’s requirement. In contrast, banks in countries with higher levels of asset risk and thus higher risk-based capital requirements, for example, Italy and Spain, are comparatively less affected by the leverage ratio, which their higher leverage ratios and higher risk density reflect accordingly
