The European Central Bank (ECB) and the European Banking Authority (EBA) have presented the results of their latest bank stress test, which covers a total of 98 euro area credit institutions (57 large and 41 medium-sized) directly supervised by the ECB. Florian Heider, Scientific Director of the Leibniz Institute for Financial Research SAFE, offers his view on the results:
“Bank stress tests are an essential but relatively new component of banking regulation in the euro area. After almost ten years, there is a good understanding among banks, their supervisors, and the markets of assessing the tests and their results. This stress test was the toughest yet, assuming an economic collapse on the scale of the COVID-19 pandemic – and yet no bank faced existential distress. However, passing the stress tests is no reason to sit back. There are three reasons for this:
First, while the assumptions for interest rate developments are realistic compared to current developments, they do not represent a truly exceptionally pessimistic scenario, unlike the assumptions for real economic performance. This reflects the nature of stress tests, which primarily analyze credit risk, not interest rate risk.
Second, financial market turmoil cannot be modeled. If such turbulence leads to illiquidity in the funding markets that are important for banks, this turbulence could also affect the banking sector.
Third, some German banks again could have fared better in the recent eurozone stress test. This applies not only to the large private banks but also to some ‘Landesbanken’. These are essential pillars of the savings bank network, though, which plays a vital role in the German banking system.”