Executive Summary

On 24 November 2015 the European Banking Authority (EBA) published the outcome of its 2015 EU-wide Transparency Exercise.

The results of the Transparency Exercise provided detailed bank-by-bank data on capital positions, risk exposure amounts and asset quality on 105 banks from 21 countries of the European Economic Area (EEA) as part of the ongoing commitment of the EBA to enhancing transparency in the EU Banking sector.

By disclosing these fully comparable figures in user friendly formats, the EBA aims to promote greater understanding of capital positions and exposures of EU banks and foster market discipline.

The outcomes of the Transparency Exercise show that, in general, the capital positions of EU banks continue to improve, while residual concerns remain in relation to non-performing loans which remain a drag on profitability.

On the back of strengthening capital bases, banks have been able to gradually increase lending into the real economy, as evidenced by the overall modest increase on overall exposures during 2015. This is a welcome development and it is hoped that the pace of bank lending will continue to increase, contributing to an increase in economic activity across EU Member States.

The Irish banks (PTSB, AIB and Bank of Ireland) all performed strongly, demonstrating robust transitional CET1 capital ratios as a result of the recapitalisation exercises undertaken by the Irish Sovereign since the start of the financial crisis. While the EBA has highlighted general concern in relation to non-performing exposures in EU banks, the meteoric recovery in the Irish economy in the last three years should mean that the high percentage of NPEs reported by Irish banks should be less of a problem over time. Against the backdrop of a vastly improved economic outlook, the prospects for further capital creation in Irish banks are excellent.


Transparency Exercise V Stress Test

It is important to note that a transparency exercise is not a stress test exercise. While both are conducted at an EU wide level for the largest banks at their highest level of consolidation by the EBA in pursuance of its mandate to contribute to the integrity transparency, efficiency and orderly functioning of EU financial markets and the stability of the financial system of the EU, there are important differences between the two, namely:

(a) a transparency exercise is a pure disclosure exercise where actual data are published, a stress test involves banks applying different levels of stress defined in common scenarios with common constraints to relevant data in order to test the resilience of banks to adverse market developments; and

(b) in a stress test exercise, bank by bank disclosure goes beyond the actual data strictly published in a transparency exercise and includes projections estimated according to the scenarios and methodology prescribed. 

The EBA decides on an annual basis whether to conduct a stress test exercise. In years where a stress test exercise is not conducted, a transparency exercise is conduced instead. 


Capital Position

The results of the Transparency Exercise demonstrate that EU banks have continued to strengthen their capital positions, mainly through raising additional equity and retaining earnings. The aggregate CET1 capital ratio for the 105 banks in the sample was 12.8%. The aggregate fully loaded CET1 ratio reached 11.8%. Capital ratios for all participating banks were comfortably in excess of the CRD IV/CRRD minima, while only ten banks had a fully loaded CET 1 ratio of below 10%.

The results show that the improvements in bank capital positions has been achieved more through increases of capital rather than RWA reductions. This is certainly true in the case of the Irish banks which underwent significant recapitalisation programmes during the period since 2011 (Irish banks did, of course, undergo significant deleveraging programmes also but the relative weighting of capital generation through direct recapitalisation versus that created by RWA reductions is in line with the EU averages identified in the results of the Transparency Exercise).

CET 1 capital has been the priority of the banks in terms of capital generation. This is as a result of CRD IV and CRRD requirements, which enforce the generation of regulatory capital with “proven loss absorption capacity”. The EBA does emphasise, however, that the “remaining capital categories are also relevant in order to achieve a cost-efficient capital structure”. The data compiled as part of the Transparency Exercise indicates that institutions have not yet fulfilled their potential in relation to T1 going concern capital and low levels of AT1 were reported. This suggest that there is scope for further AT1 issuances in the near to medium term. In this context it is notable that AIB completed a €500 million AT1 issuance in late November 2015 which was nine times oversubscribed.

The improved capital position of the major EU banks is a positive development for the EU economy as a whole. As capital positions improve, lending to the real economy should increase. Indeed, during the financial crisis the converse was true. A recent ECB paper on the topic noted the correlation between the tightening of bank credit and the worsening of the “great depression”.[1] The EBA notes that “increases in capital do not prevent banks from lending but are rather a precondition for it”.


Leverage Ratio

CRD IV /CRRD introduced a new leverage ratio requirement which will become binding from 1 January 2018. The Transparency Exercise included a set of bank-by-bank data on leverage for the first time. The EBA noted that the leverage ratios of EU banks have benefitted from capital improvements in recent years.


Asset Quality

The EBA reports that “although gradually improving, quality of assets remains a major concern in the EU and an impediment to new lending and banks’ profitability, particularly in countries already under economic stress”. By type of counterparty the Non-Performing Exposure (NPE) ratio was particularly high in the case of non-financial corporations, a category that includes (but is not limited to) SMEs.

The NRE ratio was close to 5% in cases of loans to households and 2% in loans to financial corporates other than credit institutions.

Of particular note (although not that surprising) is the geographical spread of NPE ratios. NPE ratios as of June 2015 by banks country of origin range from 1% in Sweden to 46% in Cyprus. The NPE ratio for Irish banks was 21%.  From an Irish perspective the EBA concerns in relation to non-performing exposures can be offset by the recovery in the Irish economy and the underlying increase in asset values.


Sovereign Risk

The EBA notes that a home bias is still prevalent when it comes to banks investing in sovereign exposure, however, it noted an improvement in this situation as banks reported in June 2015 an increase in their holding of non-domestic sovereign debt. The holding of domestic sovereign bonds by Irish banks contributed to the negative feedback loop between those banks and the sovereign during the financial crisis. The results of the Transparency Exercise have indicated that 70% of Irish banks’ sovereign exposure remains domestic. This exposure will need to be diversified over time to ensure that the mistakes of the past are not repeated.  


Commentary on Irish Banks

Generally the Irish banks have fared well in the Transparency Exercise. The increase in CET 1 ratios across the board is positive, however, this positivity needs to continue to translate into increased lending to the domestic economy. Nonetheless the progress that the Irish banks have made in recent years (albeit with the assistance of the Sovereign) has been immense.

Recent weeks has seen the continued normalisation of the capital structure of the Irish banks with Bank of Ireland announcing the redemption of the Preference Shares and the capital restructure in AIB. The dramatic recovery in the domestic economy should also have a positive effect on NPEs over time.