Authors: Dimitris Aloniatis, Evangelos Manouvelos

Title: Can European Banking Authority’s EU – wide Stress Tests address market anxieties?

Abstract

The European Banking Authority’s 2016 EU – wide stress tests, published on July 29 2016, demonstrated the regulatory will to soothe market anxieties and reaffirm expectations on the soundness of the EU banking system. Yet following the EBA stress tests release, markets remained skeptical on EU lenders’ robustness: sovereign defaults, the Brexit impact and a prolonged period of negative interest rates weighed heavily with markets worries.

This study analyses EBA’s Methodological Note on the 2016 EU Wide stress tests, which constitutes the common methodology EU banks should use to calculate the stress tests impacts on both baseline and adverse scenarios. Impacts on P&L account, REA and OCI, applied on Credit Risk, Market Risk, CCR, etc., are examined in order to evaluate the contribution, the necessity and the success of EBA’s stress test.

Compared to the American supervisory tradition, which focuses on market values of equity and the leverage ratio, the EU supervision focuses on risk – weighted assets, thus not capturing the full extent of market – based risks. If the American CCAR Methodology were to be used in the EU instead of the EBA Methodology this would result to a significant capital shortfall for EU banks. The debate on the finalization and implementation of the Basel IV accord is expected to showcase both the market value and book value approaches of equity.