Bank Supervisory

14 of the 24 German Banks who are challenged under the ECB Stress Test are represented by the German Bundesverband Öffentlicher Banken (VÖB). This organisation today published a review explaining the main traits of the EU Stress Test 2014. You can find the document under the following link.

Information on the Stress Test scenarios is published on the site of the European Banking Authority (EBA).

Central credit registers (CCRs) are granular databases operated by National Central Banks (NCBs). As Almeida and Damia state, “there are three main uses of CCRs: (1) to enable bank supervisors to accurately assess credit risk in supervised financial institutions; (2) to support financial transactions by assisting credit institutions in the evaluation of risk; and (3) for economic analysis.”
On a European level, the ESCB (European System of Central Banks) has been exploring the potential statistical use of CCRs from 2007 on. Related initiatives have proven the analytical usefulness of CCRs. To address remaining issues, the ESCB Task Force on Analytical Credit Data Sets was set up in 2013 to shed light on the following key issues:
(a) What further granular credit data does the ECB require?
(b) What data, including attributes on lenders, borrowers, credits and methodological aspects, should be collected from National Central Banks?
(c) How can data sets be shared across the Eurosystem/ESCB?
In 2014, the ECB decided that the AnaCredit project should have top priority with regard to the upcoming ECB supervisory task. AnaCredit is, simply put, “an IT solution (Analytical System on Credit – AnaCredit) for receiving, storing and disseminating credit and credit risk information on a euro area.” The quality of AnaCredit’s statistical evaluation depends on relevant input. As a consequence, the ESCB must ensure the transfer of European-wide  and harmonised credit data to the ECB by the end of 2016. Though the concrete data request is not yet finalised, it is already evident that banks shall report granular loan portfolio and borrower data on a loan-by-loan level. The statistical evaluation of this data shall support the ECB’s credit and credit-risk analysis which is required for the conduct of monetary policy, micro-prudential supervision and financial stability.

Today, the European Banking Authority (EBA) released the 2014 EU wide stress test methodology and macroeconomic scenarios.

Among others, the methodology states that the stress test is conducted on the assumption of a static balance sheet. The zero growth assumption applies on a solo, sub‐consolidated and consolidated basis for both the baseline as well as the adverse scenario. No workout of defaulted assets is assumed in the exercise. In particular, no capital measures taken after the reference date 31/12/13 are to be taken into account.

The adverse scenario is designed by the ESRB. According to the EBA, it reflects the systemic risks that are currently assessed as representing the most pertinent threats to the stability of the EU banking sector: (i) an increase in global bond yields amplified by an abrupt reversal in risk assessment, especially towards emerging market economies; (ii) a further deterioration of credit quality in countries with feeble demand; (iii) stalling policy reforms jeopardising confidence in the sustainability of public finances; and (iv) the lack of necessary bank balance sheet repair to maintain affordable market funding.

2014_0429 stress test EU

Source: Wall Street Journal

Following, please find an excerpt of the current EBA FAQ.

What is the timeline for the stress test?

The EBA expects to publish the final results of the 2014 EU-wide stress test in October 2014. The timeline has been agreed and coordinated with the ECB and is, therefore, in line with the overall timeline of the Single Supervisory Mechanism (SSM) Comprehensive Balance Sheet Assessment.

Data templates and guidelines will be distributed immediately after the launch of the methodology and scenarios in April 2014. Advance data collection will be started immediately to be completed end of May. First preliminary results are expected to be submitted to the EBA in mid-July and near-final results tentatively early September for the final round of quality checks and then absolute finalisation of the results will be just ahead of publication. Precise deadlines for the data submission of banks will be defined and communicated by the CAs.


How will data and results be published?

The most important aspect of the EBA’s common EU-wide exercise will be the disclosure of comparable and consistent data and results across the EU. Results will be disclosed on a bank by bank basis and the EBA will act as a data for the final dissemination of the outcome of the common exercise. The level of granularity of the data disclosed will be at least consistent with that of the 2011 EU-wide stress test and 2013 EU-wide Transparency Exercise. It will include the capital position of banks, risk exposures and sovereign holdings.

The credibility of the EU-wide stress test rests on transparency; market participants will be able to determine for themselves how supervisors and banks are dealing with remaining pockets of vulnerability.

Summary: The AQR treatment on accounting impairment demonstrates how important prudential valuation can be in the future if the ECB continues to use it. In this case, banks will have to consider the differences between accounting and prudential valuation to ensure an adequate and integrated capital and balance sheet management, as long as accounting impairment is based on the incurred loss model. A reliance on accounting valuation to manage the balance sheet may not suffice. 


The three elements of the Comprehensive Assessment are the Supervisory Risk Assessment, the Asset Quality Review (AQR),  and the Stresstest. Together, these elements provide an in-depth understanding of material balance sheet risks. As economic risks are linked to balance sheet calculation, it is crucial to differentiate between the application of adequately interpreted accounting rules on one side, and the prudential adjustments required by the Comprehensive Assessment on the other side. The latter shall assure a proper and (more) harmonised calculation of the CET1 (Common Equity Tier1). Both, the identification of prudential balance sheet adjustments and the recalculation of CET1 is be part of the AQR. The AQR itself comprises three key phases:

  • portfolio selection: result- identification of exposures with the highest risk and portfolios which should be included in the execution phase; status: completed
  • execution: result:-identification of prudential balance sheet adjustments ; status: on-going
  • collation: result- AQR adjustment calculation to CET1; status: scheduled for July 2014

With respect to the close relation between accounting and prudential valuation it is important to note that the “AQR should not be seen as an attempt to introduce greater prescription into the accounting rules outside of the existing mechanisms.” Among others, the following questions arise:

Impact of the prudential AQR valuation adjustments on bank accounting: The ECB states that “Banks would not be expected to incorporate into policies, processes or reporting findings from the AQR that relate to a bank failing to be the right side of the ECB threshold if they are compliant with the relevant accounting principles. The bank would not be required to restate accounts or apply the AQR assumptions on an on-going basis, i.e. the AQR-adjusted CET1% is not a de- facto alternative accounting standard.”

Treatment of prudential adjustments on accounting valuation in the course of the Comprehensive Assessment: “The AQR will generate a series of parameters that will act as inputs to the stress test process. The key inputs to the stress test will be: any adjustments to data segmentation highlighted by DIV, an AQR-adjusted Common Equity Tier 1% (CET1%) parameter (to allow the impact of the AQR to be applied to stress test projections of the CET1%) and probability of Impairment (PI) and Loss Given Impairment (LGI) parameters for use in the stress test. The way these parameters will be used in the stress test is pending the final methodology for the stress test, which is currently underway. As mentioned, the AQR-adjusted CET1% will be used to compute the final stress test outcomes.” One follow-up action of the ECB can be, however, to ask banks to capitalise for a shortfall relative to the ECB threshold in incremental Pillar 2 capital requirements.

Consequences if the ECB concludes that the accounting rules used by the bank are not in line with best practice interpretations: Following completion of the Comprehensive Assessment, “NCAs will produce a letter to significant banks outlining any areas where the bank is found to be outside of accounting principles and the required remediation actions the bank would be expected to take (including adjustments to the carrying values of assets). These issues would be expected to lead to adjustments to available capital and hence be reflected in Pillar 1 capital requirements at the next relevant reporting date. For the purposes of clarity,  areas where the bank falls short of the “ECB threshold” but is in line with accounting standards would not be included in the letter to the bank.”

The  case of prudential impairment calculationIAS 39, Para 59 (EU) states: “A financial asset […] is impaired and impairment losses are incurred if, and only if, there is objective evidence of impairment as a result of one or more events that occurred after the initial recognition of the asset (a ‘loss event’) and that loss event (or events) has an impact on the estimated future cash flows of the financial asset […] that can be reliably estimated. It may not be possible to identify a single, discrete event that caused the impairment. Rather the combined effect of several events may have caused the impairment. Losses expected as a result of future events, no matter how likely, are not recognised. […]” The ECB defines the following approach in its AQR-Phase2-Manual: “Initially, the NCA bank team will compare the impairment triggers of the significant bank as of December 31st with the minimum triggers provided in Table 38 of the manual and the loss events stipulated IAS 39. Where the significant bank has defined additional or more conservative triggers, these should also be taken into consideration in addition to the minimum triggers. This implies that the evidence of impairment definition is at least as conservative as the significant bank’s current classification.The NCA bank team should assess each exposure in the sample for objective evidence of impairment on December 31st 2013. This requires a two-step approach:

  • First, assessment for each exposure whether a loss event has happened based on the triggers provided. Not all of the triggers apply to each debtor (e.g. CDS is not relevant for retail mortgages or large SME).
  • Second, for each exposure with a loss event, the assessment whether the loss event has an “impact on the estimated future cash flows” of the exposure. If this is the case, the exposure will be considered as having evidence of impairment.“

In contrast to the above mentioned criteria, current or past cash flows do not necessarily need to be impacted for an exposure to be considered impaired according to IAS 39. Additionally “NCA bank teams will classify exposures as having evidence of impairment irrespective of whether the impacted future cash flows indicate that an impairment loss should be registered (i.e. impaired loans where impairment loss is assessed as 0 due to collateral should be viewed as being impaired because cash flows will be impacted by the foreclosure of collateral).”

2013 was a year full of new regulatory impulses. 2014 is the year of major changes in Bank Regulation and Supervision.
The ECB Supervisory Board convened for the first time this year in January.  Following this meeting, Ms. Nouy, Chairperson, stated: “We have to accept that some banks have no future,” and: “We have to let some disappear in an orderly fashion, and not necessarily try to merge them with other institutions.” This statement is remarkable as main preconditions to restructure the European financial system are still work in progress. Current issues are:
         Which banks „have no future“?
         Who decides if a bank shall be liquidated?
         Who pays for it?
Banks with no future: Since February this year, Joint Supervisory Teams and auditors collaborate to conduct an on site Asset Quality Review.  Its outcome is meant to identify European banks that might be restructured or liquidated if they do not meet the thresholds set by the joint ECB and EBA stress tests. Final results of the Comprehensive Assessment are expected in October 2014 at the latest. We expect further stress tests to follow.
The decision to liquidate a bank and the source of the funds required to do so: These are major issues currently discussed by the European lawmakers, which are scheduled to be resolved until April 2014 before the EU parliament adjourns for May elections.
Last week’s negotiations between EU precidency, commission, parliament and council established the following concerning the resolution decision:
  • The ECB will be charged with the task of determining if a bank is failing or likely to fail.
  • The committee which will be charged with the decision upon the resolution of a bank is still in discussion. German Finance Minister Wolfgang Schäuble suggests decision making shall take place through the plenary session of the Supervisory Board. Other interested parties are asking for more independence from national influence and favor a decision by the Executive Board. The final decision lies either with the commission or the council.

Concerning the funding of the resolution costs it appears that Finance Ministers across the EU recognize a common need to demonstrate the European financial system’s robustness in a crisis. Clearly, the time period allowed for the SRM fund’s pooling will be key to signaling this strength. Accelerated funds pooling and/or an additional backstop such as the ESM are possible approaches. Details are currently debated as well.

In view of these developments, movement toward restoring market credibility and restructuring the European financial system can be seen. The question remains: Who pays the bill? The ongoing negotiation on the SRM funds are connected to points already set in 2013: SRM funds shall only be used after Bail-In has taken place. The Bail-In rules will enter into force on January 2016, together with the pooling of SRM funds.
In the meanwhile and with respect to the 2014 Comprehensive Assessment results, EBA and ECB asked the European Finance Minister to help banks “disappear in an orderly fashion“ by making sure that there are national resources available to carry potential recapitalisation or resolution costs. It is essential that each country contributes its part. This understanding is also mirrored by the  ESM-regulation. It states that ESM funds shall only be used for direct bank recapitalisation if the respective country cannot provide the required stake.

Dear All,

Thank you for your interest in bankenanalyse throughout 2013. This year was marked by fundamental changes in bank regulation. In 2014, we look forward to more transparency on the impact on the regulated and shadow banking system. Future research and market adjustments will show if the goal to increase financial stability, as set by the G20 Finance Ministers in 2008, can be reached. The European Banking Supervisory Board will play a crucial role in this.

The next Bankenanalyse posts will appear starting February 2014. We wish you the best for a festive season and a prosperous new year.

Your Bankenanalyse


As this year comes to a close, we want to use the opportunity for an open letter to Mrs. Danièle Nouy, appointed chairperson of the Supervisory Board at the ECB, concerning the Single Rule Book with respect to goals and challenges of 2014.


Dear Mrs. Nouy,

the responsibility you assumed is probably the most challenging in banking business today. To qualify what is meant by “challenging” , we refer to your role as Chairperson of the Supervisory Board, which does not only require diplomacy, handling various interests which European Economies and Finance Ministers have, but also requires a strong leadership to assure consistent supervisory work which focuses on a harmonised European playing field. As defined by the G20, bank comparability and transparency is crucial to restore confidence in the regulated banking system. This is also valid for the shadow banking activities. Much work has been done so far: the fundament of the European Banking Union, the Single Rule Book, will come into force starting January 1st. To achieve the goals set, political and operational challenges must be addressed.

The potential renationalisation of bank rules presents a huge challenge on the political side. A prominent example of this is the reclassification of Deferred Tax Assets. A basic guideline of the Single Rule Book stipulates that regulatory capital has to be fully paid in. Spanish banks, by contrast, use a reclassification to improve capital ratios. This example should not be construed as fingerpointing. It is simply an example for different economic situations requesting national solutions which may be in contrast to the Single Rule Book.

On the operational level, it will be crucial to understand and react to bank’s market behavior. Let us take the connection between state finance and banks as an example. The Italian sovereign exposures of domestic banks amount to about 9 percent of the assets, mostly in trading and available-for-sales accounts. As the Monetary and Capital Markets Department of the IMF states, „this exposure is relatively large compared to other advanced economies, and Italian sovereign spreads have been experienced periods of above- average volatility. Mark-to-market valuation losses could affect bank solvency, while lower market prices for sovereign bonds would reduce their collateral value for secured funding, including from the ECB. Besides direct effects, the experience of the European debt crisis suggests that acute sovereign distress can have a broader impact on the economy, further aggravating pressures on the financial sector.“ To reduce the exposure towards mark-to-market losses by rising rates, it is plausible to see more and more banks shifting sovereign bond from their available-for-sale portfolios to held-to-maturity, which will mitigate the impact that movements in the bond markets have on their tangible book values and common equity. These adjustments have an impact on key figures. A proper understanding of how figures are interconnected is essential. To remain with the Italian bank example, a high sovereign exposure goes together with a relatively high rate of ECB eligible collateral. This has a positive impact on liquidity ratios. The asset encumbrance ratio for Italian Banks shows two main patterns: first, it significantly increased from 2011 to 2013. Second, government bonds remain the main source of unencumbered assets. A decrease in mark-to-market value may have a significant impact on the asset encumbrance ratio and the possibility to refund in stressed sovereign markets.



12-2013_ECB eligible collateral

Supervisory Reporting, which is addressed in the Single Rule Book, does reference these connections. It remains a challenge to draw the right conclusions, as each market and jurisdiction, but also each bank’s business model has its own logic. This already becomes evident in the course of the Comprehensive Assessment.

Currently, the ECB collects information in preparation for the Comprehensive Assessment. Key questions, which are basic for restoring confidence in the European bank balance sheets, are still open to be answered. What level of provisions will the ECB require against nonperforming loans? How will it stress test banks’ exposure to sovereign debt? How will it stress test the safety and soundness of bank funding structures, including continued reliance on ECB facilities and the recent sharp rise in ultra short-term market funding? In the words of Simon Nixon (WallStreet Journal): „What is becoming clear is that the Comprehensive Assessment may not be as comprehensive as some had hoped. The ECB will be bound by existing national rules relating to provisions and quality of capital. Indeed, some officials fear the ECB is being burdened with excessively high ambitions: It is unrealistic to expect the Comprehensive Assessment to lead to a miraculous transformation in the euro zone’s financial landscape. Yet without a transformation in the financial landscape, the ECB is likely to come under further pressure to adopt radical measures to ease borrowing costs in the periphery.“

There are many questions to be answered on the course to developing a European financial system.

Bankenanalyse sees two key ingredients which are required to handle these challenges. These are structures allowing swift and decisive decision making as well as staff which is taking responsibility to address operational hurdles and level inconsistencies to reach the defined goals.

With best wishes for a peaceful festive season and a successful 2014,


In October 2013, the European Banking Authority (EBA) published binding clarification for what constitutes forbearance and non-performing loans. Apparently, the ECB is keen to use these long awaited definitions in its Asset Quality Review, as the identification of stressed but not impaired exposures is at the core of the Comprehensive Assessment.

According to the EBA an accounting impairment is required if the loan is classified as non performing. The current challenge lies in the fact that it is not obvious how to treat forbeared but performing loans as the EBA’s understanding differs from the understanding from eg. the ESMA or the FSA. The treatment of forbeared loans was also not clear before. In the BoE’s December 2011 Financial Stability Report focussing on UK-Banks, the bank reports that forbearance actions do not appear to be fully reflected in lenders’ provisioning processes. With regard to this report, Deloitte states „there is potential for under-provisioning in relation to forbearance caused by:

  • Inaccurate data regarding loans subject to forbearance.
  • Overly optimistic assumptions used in determining the timing and size of cash flows from forborne loans in specific impairment assessments.
  • Inappropriate inputs for collective assessments, which do not reflect the particular characteristics of loans subject to forbearance. For example, should the PD be higher for commercial real estate loans subject to forbearance?“

Where does this uncertainty come from?

To determine a comparable playing field, it is clear that harmonised definitions are key for the success of a unified European Bank Supervisory. So far so good. The challenge: In clarifying this, is it not visible to what extent the IASB was consulted. IAS 39.59 defines triggers indicating an impairment exposure, whereby such events include significant financial difficulties of the obligor. As mentioned above, the question is in how far forbearance defined by the EBA triggers an accounting impairment in case the loan is performing. In other words: Are there forbeared but performing loans that should actually be classified as non performing according to the concept of the EBA? The definitions and interpretations pronounced by different regulators do not yet fit together. According to the ESMA, lender granted concessions that the lender would not otherwise consider due to the borrower’s financial difficulty indicate an accounting impairment. The UK-based FSA has a similar understanding. As Deloitte states in its UK-based review „Loan forbearance. No such thing as free lunch“: „The granting of forbearance is likely to constitute an impairment trigger, meaning that the loan should be assessed 
for impairment, either individually or as part of a collective assessment. Lenders should also assess whether borrower requests for forbearance amount to impairment triggers – even where forbearance is not granted – as the request may imply the borrower is in financial difficulty.“

Why is this uncertainty crucial with respect to the Asset Quality Review?

We touched upon the experience made in Spain in an earlier article. This showed that Asset Quality Reviews focus on assessing the default probability as well as the loss given default estimates. In using the EBA-definitions, the ECB enjoys a range of interpretation on what constitutes adequate PDs for forebeared but performing loans and on if relevant loans should be classified as non performing loans. It is probable that some banks may have to adjust their PD assessments contingent on the final understanding of the ECB. This in turn may have an impact on accounted impairments. In addition, changing PDs as well as LGDs will impact the minimum capital requirements of banks using the Internal Ratings Based (IRB) approach. The impact will be defined in the course of the Capital Stress Test expected to start in mid 2014.