The European Central Bank (ECB) commenced a rigorous analysis of European bank balance sheets over a twelve month period beginning in November 2013. Despite the complexity and scale of this undertaking, the central bank is set to provide lenders with the results on October 24 with a public release two days later. The test comes ahead of the ECB assuming fully responsibility for banking supervision under the Single Supervisory Mechanism in November 2014 and is another step towards full scale banking union and also includes deposit guarantee schemes and bank recovery and resolution directives.
The ECB has stated that the money transmission mechanism in Europe is broken. Despite a number of initiatives put in place, lending to individuals and especially SMEs continues to fall and the cost of borrowing varies significantly across the continent. The Comprehensive Assessment is aimed at addressing issues in the banking sector which will ultimately help unblock the channels in monetary policy.
The Comprehensive Assessment has three goals – improve transparency by enhancing the quality of information on the condition of banks; repair banking by identifying and implementing any necessary corrective actions; and build confidence in the banking system so that all stakeholders are assured that banks are fundamentally sound.
It will follow a three stage approach covering 131 banks representing around 85% of total Eurozone assets.
A risk assessment of individual bank balance sheets to identify the main risks and potential shocks which they could be exposed to using data submitted for the financial year ending in 2013.
An Asset Quality Review (AQR) that will focus in detail at the valuations and exposures of all the assets held by banks including sovereign debt, impaired loans and hard-to-value assets
The ECB will impose a stress test on bank balance sheets which will analyse their resilience to a baseline and an adverse scenario over a three-year horizon.
The ECB is taking the right course of action to establish supervisory credibility despite the significant cultural and political upheaval which accompanies this goal.