EBA publishes its sixth semi-annual report on risks and vulnerabilities of the EU banking sector

The European Banking Authority (EBA) published today its sixth semi-annual report on risks and vulnerabilities of the EU banking sector. The report highlights that throughout 2014, European banks have continued to take advantage of favourable market conditions to raise capital in preparation for the asset quality reviews (AQR) and the 2014 EU-wide stress test. The average common equity tier 1 (CET1) ratio for the largest European banks reached 11.8 % in June 2014, the highest level since 2009 and broadly in line with the largest US banks. The report informs that market sentiment and confidence is improving. However, it also warns that the signs of recovery remain modest and fragile and that weak macroeconomic conditions can further affect credit quality. The heavy debt overhang, the potential impact of conduct-related issues, and the sustainability of business models and profitability remain sources of concerns.

Throughout 2014, European banks have continued to benefit from generally favourable market conditions to raise capital. Between January and September 2014 alone, the largest European banks raised EUR 53.6 billion of equity (EUR 39.2 billion net of repayments and buybacks) and EUR 39.1 billion of contingent convertible instruments (both additional Tier 1 and Tier 2), in preparation for the release of the results of the 2014 EU-wide stress test. The capital raised allowed banks to continue the repair of their balance sheets through front-loading impairments and additional provisioning.

The results of the 2014 EU-wide stress test, released on 26 October 2014, confirmed the progress of the EU banking sector and the overall resilience of the major banks to adverse shocks. However, the report also notes that there is no room for complacency and more needs to be done in order to meet incoming regulatory requirements and foster consistency of risk-weighted assets (RWAs).

The quality of banks' loan portfolios in general has not further deteriorated, but credit risk is still high. In the first half of 2014, the ratio of impaired and 90-day past due loans to total loans decreased slightly to 6.4 % from 6.8 % in December 2013. However, the share of banks with a coverage ratio below 25 % increased markedly from 13.2 % to 19.9 %. EU banks' income and profitability is still under significant pressure, which is unlikely to dissipate in 2015. The main drivers are asset quality deterioration and the balance sheet clean-up, as well as, litigation costs related with conduct and IT risk. The pressure on profitability, combined with modest growth outlook will continue to present a challenge for management in terms of sustainability of some banks' business models. The report also highlights geopolitical risks and potential distress in emerging countries like Russia and China.

Finally, the report concludes with references to policy implications and to the need for supervisors to develop a coordinated analysis of banks' business models across the EU as well as to perform benchmarking work on the outcomes of banks' internal models.