The European Court of Auditors has criticised the stress tests which saw 48 banks pass muster in 2018.
However, the ECA are concerned some banks were let off lightly while other risky banks which should have been included were not tested at all.
The ECA report says: “The macroeconomic stress scenario was one of worsening economic conditions relative to the baseline scenario, but the shock was less severe than originally communicated.”
The ECA also suggested that in the scenario used, the negative effects of the shock were concentrated in several large economies, most of which performed quite well during the last recession, rather than concentrating on countries that were most affected by the financial and economic crisis.
It also suggests that the scenario used did not test banks against severe financial shocks, and some relevant systemic risks were insufficiently taken into account.
The report says: “The 2018 stress test imposed less severe adverse scenarios in countries with weaker economies and more vulnerable financial systems. For this reason, the low impact on certain banks may have been due not to their better health, but rather to a lower stress level being applied. The auditors also found that not all vulnerable banks were included in the test and that certain banks with a higher level of risk were excluded.”
The auditors note that EBA’s starting point for selecting banks was the amount of assets, but then says that the EBA then took an ad hoc decision to exclude some banks while the selection process used left out others.
“The EBA did not consider the systemic risk that banks may pose to the financial system. As a result, not all vulnerable banks were included. Some of the banks that were not included had recently been subject to restructuring, were from countries where banks have considerable exposure to their own sovereign bonds or have a high concentration of non-performing loans.”
Some vulnerable banks left out
It says the largest banks were included until the sample covered roughly 70% of euro area banks in terms of total consolidated assets as well as roughly 70% of non euro-area banks. This meant that the actual threshold for banks in the euro area was €100bn not €30bn which led to the exclusion of some countries with weaker banking systems.
“We found that the Board of Supervisors eventually excluded seven banks with assets above €30 billion, as they were either undergoing restructuring or merging with another bank, or their consolidated assets had dropped below the minimum threshold by the time the sample was adopted.
“Banks that are undergoing restructuring and that have received State aid are amongst the most vulnerable. Lastly, amongst the excluded banks were banks in which capital gaps eventually emerged.”
The auditors were also concerned that due to the lack of resources and the current governance arrangements, the EBA relied on national supervisors.
This meant it was not in a position to ensure “comparability and reliability of methods, practices and results”. The ECA says this ran contrary to the intention of the EU banking legislation.
Neven Mates, the member of the European Court of Auditors responsible for the report, said: “European banks should have been tested against more severe financial shocks. Moreover, key decisions at the EBA are taken by representatives of national supervisors and an EU-wide perspective was not sufficiently taken into account in the way the test was designed and conducted.”
The report does acknowledge that a lot of useful information has been produced and the EBA completed the tests on a very tight timetable.
The ECA has made three recommendations for the EBA.
- increase the geographic spread of its tests and select banks based also on systemic risks, rather than just on size
- define minimum stress levels for the EU as a whole and consider risks from the point of view of an EU-wide financial system
- enhance its control over the test design and strengthen its supervisory approach
In a diplomatic reply, the EBA said: “The EBA takes note of the recommendations made by the ECA and welcomes the constructive challenges that the ECA’s independent review provides, being cognisant that the EU-wide stress test can be improved further. Among the recommendations listed, the ECA prescribes to develop a top-down approach for stress tests to complement the current bottom-up approach, to expand the criteria to assess the sample of the exercise and to publish all banks’ minimum requirements. The EBA is committed to considering the ECA’s recommendations in its ongoing discussion on possible longer-term changes to the EU-wide stress test.”