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RISK ASSESSMENT OF THE EUROPEAN BANKING SYSTEM

December 2015

Core Content Summary

This report, published by the European Banking Authority (EBA), provides a comprehensive risk assessment of the European banking system as of June 2015. It outlines the key developments and trends affecting the sector since the end of 2014 and discusses the main microprudential risks and vulnerabilities. The report also presents policy implications and possible measures to address these risks.

Main Points

Capital Position

• EU banks have continued to strengthen their capital position, with the weighted average CET1 ratio rising to 12.5% in June 2015, up 40 basis points from December 2014.
• CET1 capital increased by 6.1% in the first half of 2015, while risk-weighted assets (RWAs) increased by 2.5%.
• The increase in capital was driven more by capital growth than by a decline in the denominator.

Asset Growth and Quality

• Loan growth in the EU banking sector has been modest, with a 3.6% year-to-date increase compared to 1.4% for total assets.
• The ratio of impaired and past due (>90 days) loans to total loans decreased to 6.4% in the first half of 2015 from 7% in December 2014.
• Asset quality trends vary significantly by country and bank, with expectations of further gradual improvement tied to economic recovery.
• Coverage ratios improved due to a reduction in impaired gross loans, though changes in loan provisions are expected with the implementation of IFRS 9.

Exposure to Emerging Markets (EM)

• EU banks had EUR 2.3 trillion of exposure to EM countries as of June 2015.
• Currency depreciation in EM countries could negatively impact EU banks through defaults and reduced revenues.
• Commodity price volatility also affects EM economies, particularly those reliant on exports.

Funding and Liquidity

• Funding spreads for EU banks remained volatile, reflecting a fragile financial market environment.
• Subordinated funding issuance was lower than in previous years.
• Customer deposit volumes remained stable, even during the Greek crisis, with low interest rates not deterring deposit growth.
• The liquidity coverage ratio (LCR) became applicable from 1 October 2015, with the EBA publishing final ITS in June 2015 to ensure proper reporting.

Profitability

• The weighted average return on equity (RoE) for EU banks was 7.8% as of June 2015, a significant improvement from 3.5% in December 2014 and 5.7% in June 2014.
• Despite this improvement, profitability remains weak due to low interest margins, increased competition from shadow banking and fintech, and low asset quality in many jurisdictions.

Operational and Conduct Risks

• ICT-related operational risks remain a key challenge, with cyberattacks increasing in scope and sophistication.
• Conduct risks are elevated, including issues related to foreign exchange, trade sanctions, and payment protection insurance.
• Litigation and redress costs are expected to remain a concern, though some cautious improvements are anticipated.

Key Risk Indicators and Data Sources

• The EBA uses 53 key risk indicators (KRIs) collected quarterly from 55 European banks in 20 EEA countries since 2009.
• These indicators cover asset quality, capital, liabilities, profitability, and operational risks.
• The sample banks account for at least 50% of the total assets in each national banking sector.
• The report also draws on supervisory reporting, RAQ responses, microprudential expertise, and informal discussions.

Regulatory Developments

• The EBA has issued 22 additional RTS and 10 ITS in the first half of 2015 to promote regulatory convergence.
• Work is ongoing on IRB approach reforms, including guidelines on default definition and materiality thresholds for past due credit obligations.
• A comprehensive response to the industry is expected in the near future.
• The final draft RTS on the IRB assessment methodology is scheduled for publication by the end of 2015.

Policy Implications and Measures

• The report highlights the need for continued regulatory alignment and supervisory coordination.
• It emphasizes the importance of improving asset quality and capital adequacy.
• Liquidity management and funding strategies are key areas for attention.
• ICT security and conduct risk mitigation are recommended as important steps to enhance resilience.

Conclusion

The European banking system shows improvement in capital and asset quality, but profitability remains weak and operational and conduct risks are still significant. Emerging market exposures and currency depreciation pose potential threats, while regulatory reforms are ongoing to ensure consistency and robustness in the banking sector. The report underscores the importance of supervisory oversight, risk management, and policy coordination in addressing these challenges.