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Comprehensive Assessment Stefan Kerbl, Principal Expert, ECB

Comprehensive Assessment Stefan Kerbl, Principal Expert, ECB. Sunday 26 th October 2014. Introduction to the comprehensive assessment. The three primary aims of the Comprehensive Assessment are transparency, repair and confidence building.

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Comprehensive Assessment Stefan Kerbl, Principal Expert, ECB

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  1. Comprehensive AssessmentStefan Kerbl, Principal Expert, ECB Sunday 26th October 2014

  2. Introduction to the comprehensive assessment The three primary aims of the Comprehensive Assessment are transparency, repair and confidence building Enhance the quality and quantity of information available on the condition of banks Transparency Identify and implement necessary corrective actions, if and where needed Repair Confidence building Reassure all stakeholders that SSM banks are fundamentally sound and trustworthy

  3. Introduction to the comprehensive assessment The Comprehensive Assessment comprises of two main components – an Asset Quality Review and a Stress Test

  4. Introduction to the comprehensive assessment The exercise was comprehensive in its scope and nature Comprehensive in scope Comprehensive in nature 19 participating countries 130 participating banks 82% of total SSM banking assets covered Every portfolio of every participating bank examined and a risk-based sub-set selected for review in extensive detail 816 individual portfolios examined in detail 119,000 debtors analysed in detail 170,000 collateral items (re)valued 825 provisioning models challenged 4,500 securities revalued 70 derivative pricing models reviewed

  5. Stress Test recap Scenario building blocks: four main sources of risk starting with global vulnerabilities Access to and costs of bank funding impacted Domestic demand confidence-driven shocks Sovereign bond yield differentiation Global sources of risk • Increased risk aversion, broad-based sell-offs and re-pricing • EMEs specifically impacted, with a severe decline in world trade • Currency depreciation and funding stress in CEEs

  6. Stress Test recap Three important features distinguish the ECB CA stress test from previous EU-wide stress test exercises a comprehensivemethodology prescriptive also for parts of the stress that are less focussed on previously (NII, PPP) 2. a systematic and centrally-led quality assurance process Thoroughly defined QA approach in the CAST manual Each bank had to provide up to 307,000 data points (circa 40 million in aggregate) Involving 100FTEs at central ECB level and hundreds of FTEs across the SSM 3. The thorough assessment of starting values via the AQR a join-up process for the AQR and stress test outcomes Both book values and risk parameters Mechanistic and comprehensive Detailed description of the methodology in the CAST manual

  7. Annex

  8. Stress Test recap AQR results will be used to adjust starting point and stress test projections The join-up process connects and reinforces the ‘point-in-time’ AQR and the ‘forward-looking’ stress test, thereby strengthening the overall exercise The join-up is in line with some previous national exercises (e.g. Spain, Cyprus, Slovenia) – but unparalleled on the euro area level The AQR findings impact on the starting point CET1 ratio of all banks Where the AQR identifies material issues, these is also used to adjust bank’s forward looking stress test results (e.g. loan losses)

  9. Stress Test recap • Quality assurance (QA) was a key ingredient for ensuring credible results from a constrained bottom-up stress test • Enhance accuracy and credibility by providing a systematic review of individual bank results • Key objective to minimise the risk that banks passing the stress-test will subsequently fail • Also key for ensuring a level playing-field in a multi-country context • Quality Assurance scope: • Stress test results (baseline and adverse scenario) • Stress test results including the join-up impact • Efficient framework for QA by focusing on material issues (traffic light approach)

  10. Stress Test recap ECB CONFIDENTIAL A central QA framework has been put in place to review results from individual and cross-country perspectives and by risk dimension The central QA framework Specify a number of quantitative checks to be performed on banks’ submitted results. These constitute a minimum standard to be applied consistently across all countries, with Red/ Amber/ Green (RAG) thresholds. employs ECB top-down stress test models, in-market and cross-market comparisons harnesses complementary qualitative information on each bank (e.g. reviewing explanatory notes) Three lines of defence: NCA bank teams – NCA centrally – ECB

  11. On the Results

  12. Comprehensive Assessment results

  13. Comprehensive Assessment - key figures Comprehensive Assessment results • Key results • The Asset Quality Review (AQR) results in a gross impact on asset carrying values of €48 billion • In total, a €136 billion increase in non-performing exposure was identified • Combining the AQR with the stress test the Comprehensive Assessment results in: • - €263 billion capital depletion over the three-year horizon of the exercise under the adverse stress test scenario • Median 4% reduction of the CET1 capital ratio of in scope banks • In aggregate, the Comprehensive Assessment resulted in a €24.6 billion capital shortfall across 25 participant banks

  14. Comprehensive Assessment results Comprehensive assessment identified a capital shortfall of €24.6 billion across 25 banks Comprehensive assessment capital shortfall by driver SSM level (€ BN) +2.7BN +10.7BN Note: Numbers do not add up due to rounding

  15. Comprehensive Assessment results Capital shortfall was observed at banks from 11 of the 19 countries in scope of the exercise Comprehensive assessment capital shortfall by driver By country, as % RWAs Total shortfall (€ BN)

  16. Comprehensive Assessment results The median bank’s CET1 ratio falls by 4% in the adverse scenario Comprehensive assessment impact on CET1 ratio under the adverse scenario Median by country of participating bank, % • Median bank’s CET1 ratio declines from 12.4% to 8.3% SSM median: 4.0%

  17. Asset Quality Review results

  18. Across the SSM, the Asset Quality Review (AQR) led to a €48BN adjustment to asset carrying values Asset Quality Review results Asset Quality Review impact on available CET1 capital By AQR workblock (€ billion) Other capital adjustments Additional provisions Projection of findings Impact from risk-based sample

  19. The AQR led to an €136 BN increase in non-performing exposure, with increases across all asset segments Change in NPE exposure, pre- and post-AQR By asset segment (€ billion) Commentary Asset Quality Review results • Divergent bankdefinitions of non-performing exposures were harmonised leading to €55 billion added non-performing exposure • Following harmonisation, an increase in non-performing exposure of €81 billion was observed in the credit file review • In total, non-performing exposure increased by €136 billion, representing a 18% total adjustment Individually assessed (credit file review) Collectively assessed (collective provisioning) +18% +19% +33% +14% NPE exposure (€BN) +4% +1% +36% +73% +31%

  20. Provisioning increased by a total €43 BN across all asset segments Commentary Change in provisions By Asset Segment (€ billion) Asset Quality Review results • Total specific provisions increased by €43 billion, a 12% overall adjustment • Provisions increased as a result of both the credit file review and collective provisioning workblocks • Shipping (28%), Large SME (16%) and Large Corporates (16%) experienced largest relative increases Individually assessed (credit file review) Collectively assessed (collective provisioning) +10% +16% +16% Provisions (€BN) +12% +6% +5% +28% +10% +5%

  21. ECB identified banks in where debtors were hitting triggers but not being classified as NPE • ECB discussed with NCAs and challenged auditor decisions at the individual debtor level • In some cases the decision against reclassification was justified • In a significant number of cases, decision was withdrawn and the debtor reclassified to NPE along with debtors in similar scenarios Asset Quality Review results ECB Quality Assurance had a tangible impact on NPE classification, ensuring harmonised treatment Example of impact of ECB Quality Assurance Number of performing debtors hitting 2 or more impairment triggers, pre- and post- ECB Quality Assurance (%) Remedial approach taken

  22. Asset Quality Review results ECB Quality Assurance resulted in a significant increase in collateral haircut levels Example of impact of ECB Quality Assurance Mean collateral haircuts pre- and post- ECB Quality Assurance (%) Remedial approach taken • ECB reviewed haircut levels across NCAs for each asset segment • ECB discussed with NCAs and challenged auditor decisions at the individual debtor level • In some cases the ECB accepted the NCA submission • In others additional haircuts were agreed and applied Note: The exhibited number of banks is not necessarily exhaustive for the example NCA

  23. Asset Quality Review results In total, collective provisioning led to an increase in provisions of €16BN, of which 62% was IBNR Collective provisioning adjustment – IBNR SSM-level, € billion • In total, more than 800 portfolios across most AQR asset classes were assessed • Collective Provisioning workblock identified the need for additional collective provisions of €16 billion, • - €6 billion of retail specific provisions • - €10 billion of additional IBNR • Key drivers included • Application of EBA simplified NPE definition • Credit file review findings leading to adjustments in LGI parameter • Adjustments to RRE collateral values impacting LGL • Bank use of non point-in-time parameters +23% Collective provisioning adjustment – specific provisions SSM-level, € billion +6%

  24. Asset Quality Review results Collective provisioning Quality Assurance aligned parameters to ECB defined fall back assumptions Collective provisioning parameter distribution – emergence period Distribution of performing exposures by emergence period Comparison of other fall back parameters ECB defined fall back assumption Number of exposures

  25. Asset Quality Review results The adjustment of the Fair value exposures review was €4.6 billion, with 66% from CVA adjustments Fair value exposures review adjustment By workblock (€ billion) • Non-derivative positions were assessed through independent revaluations leading to a €1.2 billion adjustment • Adjustment on CVA reserves was significant, with a 27% increase of €3.1 billion identified • Complex derivative pricing models were also reviewed, with modelling errors or inappropriate assumptions leading to a further €0.2 billion adjustment

  26. Stress Test & Join-up results

  27. Contribution of the Stress Test Overall, total adverse scenario capital depletion is €263 billion Comprehensive assessment adverse scenario capital depletion SSM level, (€ BN) Key drivers • Total gross AQR adjustment of €48 billion, and €34 billion net of tax offset • The stress test (and Join-up with AQR results) led to a capital depletion of €182 billion in the adverse scenario • In addition, the increase in RWA in the adverse scenario increases capital requirements in the amount of €47 billion Gross AQR adjustment 1Stress Test results include the impact of the Join-Up Note: Scenario capital depletion and the effect on required capital are based on the 2016 adverse scenario

  28. SSM banks' average CET1 ratio is projected to increase from 11.8% to 12.0% in the baseline Key drivers Improvement in the solvency position under the baseline mainly reflects • Projected accumulation of pre-provision profits (3.6 percentage point contribution to the change in the CET1 ratio) • Projected loan losses (-2.5 percentage point contribution) The average development of participating banks’ solvency positions, however, masks variations across individual institutions and countries Stress Test results Aggregate post-JU stress test effect1 by risk drivers under the baseline scenario 1. Weighted means; excluding the AQR impact on starting point capital

  29. SSM banks' average CET1 ratio is projected to decrease from 11.8% to 8.8% in the adverse Key drivers Increase in loan losses (-4.5 percentage point contribution to the change in the CET1 ratio) Lower pre-provision profits compared to the baseline (corresponding to a 1.3 percentage point lower positive contribution the change in the CET1 ratio) “Administrative and other expenses” have an impact on the overall results; however, they remain largely unchanged between the baseline and adverse scenario and mainly reflect staff and other administrative costs that regardless of the scenario have a negative impact on banks' loss absorption capacity Stress Test results Aggregate post-JU stress test effect by risk drivers under the adverse scenario 1. Weighted means; excluding the AQR impact on starting point capital

  30. Loan losses and net interest income are key drivers of divergence from baseline to adverse Stress Test results Aggregate post-JU stress test effect by risk drivers under the adverse scenario 1. Weighted means; excluding the AQR impact on starting point capital

  31. Corporate and retail portfolios are the key drivers of loan losses in both scenarios Key drivers Loan losses across banks are mainly driven by the corporate and retail portfolios, both under the baseline and adverse scenarios Under the baseline scenario, the median CET1 percentage point reduction due to losses is: • 0.9% in the corporate segment • 0.5% in the retail segment Results under the adverse scenario are, however, more severe with a median CET1 percentage point reduction of • 1.6% in the corporate segment • 1.1% in the retail segment Stress Test results Decomposition of loan losses across portfolios and banks under the baseline and adverse scenario Baseline scenario Adverse scenario

  32. Under the adverse scenario, the median decline in NII is larger and more varied across banks Key drivers While the picture is heterogeneous across banks, the median decline in net interest income is larger under the adverse than the baseline scenario Moreover, the distribution of changes in net interest income across banks is in general wider under the adverse scenario Stress Test results Net interest income development across banks under the baseline and adverse scenario, year-on-year % changes

  33. RWAs grow in net terms across the horizon, resulting in higher capital requirements Stress Test results RWA development across banks under the baseline and adverse scenario, year-on-year % changes Key drivers • Risk-weighted assets experience net growth across the horizon, albeit at a declining rate • For the large majority of banks under the static balance sheet assumption, the nominal balance sheet size remains the same by design • Risk weights for the median bank grow under the baseline scenario from 1.0% in the first year to 0.7% in the third year, and under the adverse scenario 3.2% in the first year to 0.9% in the third year • Increased RWAs result in higher capital requirements

  34. The stress test impact differs across banks under the static and dynamic balance sheet assumption Stress Test results Distribution of changes to CET1 ratios across banks following the static vs. dynamic balance sheet assumption under the baseline and adverse scenario, cumulative % changes Key drivers • Banks under the dynamic balance sheet assumption are less heavily affected under the baseline scenario • In the adverse scenario larger CET1 ratio declines are observed for banks under the dynamic balance sheet assumption. This could reflect that restructuring banks • Are generally weaker and more vulnerable to stress tests • May be located in countries with relatively more severe scenarios • In cases where banks provided both, static and dynamic templates, the dynamic version generally resulted in less severe effects

  35. Join-up results Join up effect varies by bank but is driven by bank AQR impact Join-up effect by bank in relation to AQR impact Key drivers • Join up effect is highly correlated with the magnitude of AQR findings • The strongest join-up effect (above 1% of RWA) is observed for banks where AQR had a major impact • For banks with small or negligible AQR findings, the join-up effects on average were similarly small (<0.2% of RWA)

  36. Impairments are the major driver of join-up effect by change in CET1 in the baseline scenario Join-up results CET1 effect of join-up by type (credit vs. other effects) under the baseline scenario

  37. Join-up results Distribution of join-up effect by type is similar, but for greater impacts overall, in the adverse scenario CET1 effect of join-up by type (credit vs. other effects) under the adverse scenario

  38. The post-JU impact of the Stress Test is 0.2% in the baseline and -3.0% in the adverse Stress Test and Join-up results

  39. On the Scenario

  40. PROCESS / STORY 1 2 ASSUMPTIONS / DRIVERS 3 RESULTS / SEVERITY DERIVED RESULTS 4

  41. Scenario building process • The baseline scenario was prepared by the European Commission • The adverse scenario was proposed by the ESRB, working in close collaboration with the ECB and the EBA, and it was finally approved by the EBA Board of Supervisors • It captures the prevailing view of systemic risks facing the EU financial system, as identified by the ESRB General Board • It includes forward-looking paths for key macroeconomic and financial variables for all EU countries and a large number of non-EU countries over a three-year horizon

  42. Scenario narrative • Starting point: global sources of risk • Increased risk aversion, broad-based sell-offs and re-pricing • EMEs specifically impacted, with a severe decline in world trade • Currency depreciation and funding stress in CEEs • Triggering EU-specific risks • Domestic demand confidence-driven shocks (real estate too) • Sovereign bond yield differentiation re-appearing • Access to and costs of bank funding impacted

  43. Scenario building blocks: Four main sources of risk leading to a set of drivers

  44. PROCESS / STORY 1 2 ASSUMPTIONS / DRIVERS 3 RESULTS / SEVERITY DERIVED RESULTS 4

  45. A selection of shocks – aggregated summary Shocks (deviations from baseline, in basis points or percentage)

  46. Equity price shocks for EU-countries – country specific (percentage deviation from baseline levels in 2016)

  47. Adverse scenario – respective role of ‘drivers’ Contributions of scenario components to GDP impact (percentage point deviation from baseline levels in 2016) • Global shocks account for c. 40% of the total GDP impact • Shocks to domestic real economic variables account for c. 45-50% of the total GDP impact • Sovereign debt shocks and bank funding shocks together account for c. 12-13% of the total GDP impact

  48. PROCESS / STORY 1 2 ASSUMPTIONS / DRIVERS 3 RESULTS / SEVERITY DERIVED RESULTS 4

  49. Key scenario variables – output for the areas Deviations from baseline levels by end-2016

  50. Comparison with past EU-wide stress tests Cumulative GDP impacts in previous CEBS/EBA stress test exercises (Deviation of adverse from baseline growth rates in percentage points)

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