As part of its Staff Working Papers, the EBA published “EU Banks’ Journey Towards an Enhanced Capital Framework” on 26 March 2019.

The paper outlines the development of the European Pillar 2 Framework and EU bank’s capital positions since 2014. The paper is well worth reading for anyone interested in the topic; more importantly, it may allow banks to conduct benchmarking analysis for their internal analysis and reporting purposes.

There were 4 charts that stood out for me as part of the paper and I will share some thoughts on each of them:

Story #1: The capital tide is rising – and it's lifting all boats

Since the financial crisis, total capital levels in the EU have risen from 11.7% (2008) to 19% (2018). The trend is unmistakable across bank sizes and is broadly seen to be driven by two related forces:

  • Gradual de-risking of balance sheets and recapitalisation after the crisis and potentially, in some cases, driven by better risk management and quantification (e.g. adoption of internal methodologies).
  • Increasing regulatory capital requirements and harmonisation of SREP frameworks leading to banks keeping higher capital to manage regulatory and internal capital demand.

Figure 1: Capital developments in the EU 2008-2018 Total Capital Ratios (LHS)

The SREP guidelines, issued first in 2014 and revisions in 2018 have been key drivers in this trend by strengthening supervisory practices as well as banks’ response (including through their ICAAPs). (See our blog)

Story #2: Actual capital increases are the possibly the stronger force

If the relative contribution of de-risking balance sheets (as assessed by falling TREAs) or rising capital levels (as assessed by actual increase in capital) to capital ratios is analysed, it seems that for banks in the sample, the improvement in capital ratios is primarily driven by increases in capital levels (blue dots above the horizontal axis).

The blue dots in the right hand quadrants partially represent an increased use of macroprudential tools and national discretions which “increase” risk quantification (e.g. Articles 124, 164 and 458 of the CRR).

Figure 2: Evolution of Total Risk Exposure Amount (TREAs) and CET1 capital (2014-2018)

Story #3: Excess capital held in the system is not insignificant 

Banks are holding significant excesses of capital against capital requirements – this remains true across different capital required (TSCR, OCR, OCR+P2G) or capital available (CET1, TC) measures (e.g. CET1 margin above TSCR or Total Capital Margin above OCR+P2G)).

At the most aggregated level, EU average of banks’ capital margins above their P2G expectations varied between 3.2 % points and 4.6 % points for the CET1 and TC margins. Importantly though, the data set contains 16 banks with total capital levels BELOW their P2G expectations.

Figure 3: Distribution of banks’ margins over various capital requirements

Story #4: Stresses in geographies seem to influence capital levels 

The paper also looked at capital margins (capital resources held less capital requirements) across “stressed” and “non-stressed” jurisdictions. Stressed countries included Greece, Ireland, Italy, Portugal, Greece and Spain.

As the chart outlines, the margin levels in stressed countries were generally lower than those in non-stressed countries, indicating that banks in these countries may be finding challenges in increasing their levels of capital or might face higher capital requirements because of their risk profile – or both.

Figure 4: TC margin above the OCR (Q3 2017) ordered by country of origin

The paper presents some very interesting patterns and insights and I encourage finance and risk professionals to review the findings and raise these points in their relevant fora for Board and senior management reflection.

Relevant abbreviations above

  • CET1: Common Equity Tier 1
  • CRR: Capital Requirements Regulation
  • ICAAP: Internal Capital Adequacy Assessment Process
  • OCR: Overall Capital Ratio
  • P2G: Pillar 2 Guidance
  • P2R: Pillar 2 Requirements
  • SREP: Supervisory Review and Evaluation Process
  • TC: Total Capital
  • TREA: Total Risk Exposure Amount (more commonly known as Risk Weighted Asset or RWA)
  • TSCR: Total SREP Capital Ratio