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EBA Recapitalisation Exercise Summary

Core Content

The European Banking Authority (EBA) initiated a recapitalisation exercise in December 2011 as part of a coordinated effort to restore confidence in the EU banking sector amid the worsening sovereign debt crisis. The exercise aimed to ensure banks have sufficient capital to withstand further shocks and to remain well-capitalised against residual credit risk.

Main Points

• Purpose of Recapitalisation:
  To address the exceptional situation caused by the deteriorating sovereign debt crisis, the EBA requested banks to set aside additional capital buffers. This was not a new stress test but a review of existing capital positions and sovereign exposures as of end September 2011.

• Capital Buffers:
  The capital requirement includes both the 9% Core Tier 1 (CT1) buffer and a temporary capital buffer against sovereign debt exposures. The latter is based on market prices and is a one-off measure.

• Sovereign Exposure Valuation:
  Banks were asked to assess their sovereign exposures in the Held-to-Maturity (HTM) and Loans and Receivables portfolios using market prices. Sovereign debt in the Available for Sale (AFS) portfolio was already marked-to-market, but the gain/loss was excluded for this exercise.

• Definition of Core Tier 1 Capital:
  The definition remains consistent with the 2011 EU-wide stress test, based on EU legislation (CRD). It includes common equity and excludes hybrid instruments like existing preference shares.

• Eligible Capital Instruments:
  Banks can use CT1 capital instruments and certain high-quality contingent capital instruments (including newly issued ones) to meet the capital shortfall. These instruments must comply with strict criteria outlined in the EBA’s term sheet.

• Exclusions and Special Cases:
  A subset of small non-cross-border banks was excluded. Greek banks were not disclosed due to pre-agreed capital targets under the EU/IMF assistance programme. The EBA also does not include Norway, Iceland, or Liechtenstein in the list of addressees as they are EEA states not under its direct supervision.

• Implementation Timeline:
  Banks were required to submit capital plans by 20th January 2012, and the implementation of these plans must be completed by 30th June 2012. The EBA and national supervisors will monitor the plans closely.

• Impact on Lending and the Real Economy:
  The EBA is not forcing banks to stop lending, but acknowledges that banks have already reduced lending due to the crisis. The goal is to ensure that any deleveraging is done through asset sales rather than reductions in credit flow. Special attention is given to SMEs to avoid excessive impact on their access to credit.

• Regulatory Considerations:
  The recapitalisation exercise does not propose changes to the accounting treatment or prudential rules. It is a one-off measure and does not conflict with future regulatory requirements, such as Basel III/CRD IV. The Buffer Convertible Capital Securities (BCCS) are not classified as Core Tier 1 capital until they are converted into shares.

Key Information

• Number of Banks in the Sample: 71, but only 65 figures were disclosed due to Greek banks' pre-agreed targets.
• Capital Shortfall Drivers:
  • Target CT1 ratio of 9%
  • Application of Basel 2.5 (CRD3) rules
  • Sovereign buffer from marking-to-market of EEA sovereigns
• Sovereign Buffer Composition:
  • ~60% from AFS portfolio (already marked-to-market under Basel 3)
  • ~40% from HTM portfolio (marked-to-market for regulatory purposes)
• Eligible Actions for Banks:
  • Issuing common equity or eligible contingent capital
  • Retaining earnings
  • Cutting dividends
  • Selling non-core assets
  • Buying back hybrid instruments and substituting them with stronger capital instruments

Methodology and Data Quality

• Data Validation:
  Competent national authorities conducted the first round of checks, and the EBA performed a second round to ensure consistency and conservatism in the evaluation of sovereign exposures.
• Valuation Method:
  Banks used market prices to assess sovereign exposures. The EBA used publicly available bond yields and sovereign-specific data for its analysis.
• Transitional Floors:
  The EBA applied Basel I transitional floors across all banks in the sample, with national authorities able to choose between two methods for application.

Legal Binding and Oversight

• Legally Binding:
  EBA recommendations are not legally binding but are based on the comply or explain principle. Competent authorities must confirm compliance within two months.
• Supervisory Role:
  National supervisors must approve the use of the BCCS instrument, and the EBA will monitor the impact of capital plans across the EU.

Conclusion

The recapitalisation exercise is a temporary, one-off measure to address the exceptional situation caused by the sovereign debt crisis. It aims to reinforce bank capital without altering the existing regulatory framework, while ensuring that deleveraging does not negatively impact the real economy, particularly SMEs. The EBA remains committed to coordinating with national authorities to achieve these objectives.