Deferred Tax Assets (DTAs) have been mentioned (usually critically) on this blog many times before. Put very simply, they are tax carryforwards that can be included in banks’ Core Tier 1 capital ratios.
Unsurprisingly then, they make quite an appearance in the recent European stress tests.
According to the European Banking Authority (EBA), the assets “are important for many banks in the sample making up around 10 per cent of total Core Tier 1 capital at the start of the exercise.” Of course, that conceals quite a big range. The percentage of Core Tier 1 made up of DTAs varies from negative 3 per cent at HSBC to a whopping 58 per cent at Allied Irish Banks and Caja de Ahorros del Mediterraneo.
Here we might need to dig into what DTAs are, exactly. As Ernst & Young pointed out last year, you’ve essentially got three types. First, you’ve got DTAs arising from deductible temporary differences — for instance the difference between the carrying amount of an asset or liability and its tax base.
You’ve also got DTAs resulting from the carry forward of unused tax credits, and DTAs from the carry forward of unused tax losses. These last ones are rather more controversial and have often been described as ‘sandy’ forms of capital since they rely on banks generating enough profit in the future to actually be able to use them. (And what are the odds a bank will be making money when it needs capital the most?)
In fact, under upcoming Basel III bank rules DTAs relying on future profit are no longer included in Core Tier 1 for just that reason, meaning just the first type of DTA will add to bank capital ratios. From our understanding, the EBA’s stress test methodology applied Basel III treatment to those DTAs.
In which case, all the DTAs shown in the below table are the relatively more benign kind — the temporary difference kind. And the fact that banks still have decent-ish Core Tier 1 ratios to report at all is fairly amazing, given how reliant they used to be on DTAs. Back in 2009 for instance, some 44 per cent of Dexia’s shareholder equity was made up of DTAs, now it’s 15 per cent of Core Tier 1.
And on that note — the data, culled from the stress test (click for the full list):