(Reuters) European Union banking regulator EBA has demanded that lenders achieve a core tier one ratio of at least seven per cent in the current round of internal stress tests, banking and regulatory sources told Reuters on Tuesday.
It remains unclear whether capital that qualifies as core tier one will be defined according to rules known as Basel III, or whether an earlier version, known as Basel 2.5 will be applied, these sources said…
Using the Reuters Breakingviews stress-test calculator and current bond prices as inspiration…
RBStress or what.
One very, very big caveat — we don’t know what sovereign “haircuts” the EBA will apply this time and didn’t get too philosophical when lobbing in some numbers. We’ll leave it to you to generate your own stress in the calculator yourselves.
All the EBA has said in an earlier release on Tuesday is that it will take account of ‘updated sovereign exposure’ following on from the original stress tests. Does that mean the original sovereign marks will be applied? TBC. It has been mooted that the EBA could use market values, but again, this is all TBC.
Another thing that we keep hoping to get some clarity on, is whether the EBA will attempt going back and clearing up some of those inconsistencies in the ways in which the original methodology was followed. Or rather, it wasn’t clear how much they managed to rectify before publishing because it was left to the respective supervisory authorities.
As there are many ways to skin a cat and many ways to construct an internal model for a stress test, there were signs at the time of how tough it was to coordinate the banks and their supervisors to achieve a semblance of consistency. In any case, here’s an excerpt from the additional methodological note released a month before the 2011 results came out:
In addition there a small number of areas where a number of banks appear to have used approaches that are either inconsistent with the methodology, and the objectives it was trying to achieve, or where further clarity has been requested from the EBA. The purpose of this additional guidance to address those thematic issues and provide further guidance on how to address them across the sample. It should not be seen as a substitute for the ongoing bilateral engagement between the EBA Quality assurance task force and national supervisory authorities and individual banks. Nor does it seek to change the published methodology.
What’s “small” in “small number of areas”? Did those “small” areas lead to big differences? Were these matters resolved? Please forgive our Dexia-sized scepticism. Concerning sovereign exposures:
The EBA Board of Supervisors decided clearly that the market risk haircuts to the value of sovereign exposures would not apply to exposures held in the banking book. However, as with any other credit risk held in the banking book, fundamental credit analysis is expected to be undertaken and banks are expected to assess the impact of the scenarios on sovereign debt in the banking book based on movements in PDs and LGDs. …
Recent heightened concerns in the sovereign debt market suggest such low PDs are inappropriate in some cases and there is increasing pressure to factor in some valuation stress to the banking book. While applying haircuts to the exposures in the banking book would not be consistent with current regulatory treatment, a consistent and conservative approach to assessing sovereign risk in the banking book should be followed.
About those sovereign haircuts — Table 3, for posterity:
Furthermore, in the actual summary of the results themselves:
the dispersion of PDs and LGDs remains material for the same regulatory portfolio and located in the same countries. A substantial dispersion may signal that the methodologies used by some banks for the estimation of risk parameters will require further analysis.
Will it now?
And last but not least…
Further caveats on RBS. This isn’t the 8 per cent core tier one target that had been seen particularly damaging the UK bank, but even at 7 per cent core tier one, no doubt RBS would still argue that the EBA’s testing and use of historical data makes their trading losses look worse than they should be.
We imagine HM Treasury must be starting to get nervous though…
By Joseph Cotterill and Lisa Pollack
Related links:
Accounting for sovereign stress - FT Alphaville
Blood from an EBA stress test stone – FT Alphaville
2011 EU-wide stress test portal – EBA