This first edition of the European Bank Capital Quarterly focuses on how banks are normalising their capital distributions while regulators utilise macroprudential measures to address potential financial stability risks stemming from stretched asset valuations. We also look at the standing of major European banks against their various solvency requirements, starting with capital and leverage and eventually adding MREL/TLAC.

“Regulators are returning to pre-pandemic supervisory practices and reducing supervisory forbearance,” said Pauline Lambert, executive director in Scope’s financial institutions team. ECB-supervised banks are now required once again to include central bank exposures in their leverage ratio exposure measures. From the beginning of 2023, the ECB will no longer give banks the flexibility to dip into their capital buffers. Banks will be expected to operate above their combined buffer requirements and Pillar 2 guidance.

The ECB returned to a full SREP cycle in 2021, following a more pragmatic assessment in 2020 that had focused on challenges stemming from the pandemic and which maintained Pillar 2 requirements (P2R) and Pillar 2 guidance (P2G) at 2019 levels. Full capital assessments were performed with SREP scores assigned and formal decisions issued rather than just recommendations. “The ECB highlighted that SREP scores remained broadly stable, but there has been a continual increase in the proportion with a SREP score of 3, meaning that the risks identified pose a medium-high level of risk to the viability of the institution,” Lambert said.

Distribution of SREP scores (2018, 2019 and 2021)

Source: ECB

There was a marginal increase in capital requirements for banks not meeting supervisory expectations related to provisioning for non-performing exposures (NPE). As these expectations were in place from end-2020, banks reduced the aggregate shortfall in NPE provisions by over 75% during 2021. But 22 significant institutions, including BNP Paribas, Intesa, KBC and Societe Generale, still had a shortfall so were subject to a new P2R add-on. As banks address these shortfalls, the P2R add-on may be removed with no need to wait for the completion of the next SREP cycle.

While the economic recovery is generally expected to continue, concerns remain about elevated valuations in real estate markets as well as high sovereign and corporate debt levels. Consequently, authorities are using macroprudential measures to reduce excessive credit growth and strengthen the resilience of banks. Some measures had been reduced or removed during the pandemic but are now being reinstated while new ones are being implemented.

Meanwhile, banks have built up a fair amount of capital during the last two years and are in a relatively good position to meet higher requirements and make distributions. “Several banks have explicitly stated their intentions to reduce capital positions to lower target levels. This is one of the levers for achieving return targets as the revenue outlook remains muted,” Lambert said.

Download the Capital Quarterly here.

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