Eight years after the financial crisis began, the results of stress tests on European banks released by the European Banking Authority (EBA) recently showed that the two Irish banks included in the tests – AIB and Bank of Ireland – compared very poorly with their peers in terms of their ability to withstand another major economic downturn.
As with previous stress tests, the EBA considered an “adverse scenario” in which the global economy suffers a severe recession, equity markets tumble and interest rates rise sharply, and they project the impact this would have on each bank’s capital position. It shows that in this scenario, by 2018 AIB’s key capital ratio – known as the Fully Loaded Common Equity Tier 1 Ratio (CET1) – would have fallen to 4.31%, the second lowest of the 51 banks in the test. Bank of Ireland’s CET1 would have fallen to 6.15%, the fourth lowest of the 51 banks.
Unlike previous stress tests, this one did not set “pass” or “fail” levels, but the pass level of 5.5% in previous tests is generally seen as the minimum required. AIB was one of only two banks to come in below that level – the other one being Banco Monte dei Paschi, which we discussed in previous Investment Notes and which showed a negative CET1 position in the adverse scenario (i.e. the bank’s capital was completely wiped out).
AIB and BOI have some justification in arguing that the timing and methodology of the tests were particularly unfavourable towards their current positions and business models, but there is no doubt that the results were a disappointment and will have implications for both banks. BOI may have to review its intention to start paying a dividend again by 2017, as future profits may have to be retained in the bank to strengthen the capital position. Shareholders’ disappointment at this is reflected in a 14% fall in the share price since Friday. As virtually all AIB shares are owned by the state, there is no meaningful AIB share price, but the results have made the already difficult task of offloading that shareholding even more challenging. It also means that any hopes that the exchequer might start to earn a dividend from the bank will be put on hold as any profits need to be retained.
For comparison purposes, the table below shows the results for various credit union counterparty banks, including their actual CET1 as of December 2015, the projected CET1 as of December 2018 under the adverse scenario, and where each one ranks among the 51 banks under that adverse scenario:
|CET1 December 2015||CET1 2018 – Adverse Scenario||Adverse Scenario Ranking (51 Banks)|
|Bank of Ireland||11.28%||6.15%||48|