The Irish banks, AIB and Bank of Ireland, show up poorly on the stress test of 51 European banks (33 in the Eurozone) released Friday night. The methodology is explained on the EBA website. Briefly, there has not been a review of each bank by a team of EBA inspectors as is implied by some of the media coverage – RTE’s bulletin referred to an ‘examination’. It is a mechanical exercise based on the ‘static’ 2015 balance sheet, as published, with no adjustment for the plausibility of provisions but also with no credit for retained earnings post 2015. The ‘stress’ is essentially a GDP downturn from 2016 through 2018 resulting in a depletion of capital adequacy as against the end-2015 balance sheet number.
The scale of the depletion reflects the extent of the assumed downturn. The essential reason for the sharper loss of capital adequacy for the Irish banks is that the downturn assumed for Ireland is greater. Against a baseline, the cumulative adverse GDP shock for the main Eurozone countries included is as follows:
The adverse shock assumed for Ireland is the largest and 3.2% above the average for the others shown. There are some other factors but the EBA release makes it clear that these numbers are the main driver of the projected capital depletion. The basis for the large Irish shock is a calibration against the experience over 2008 to 2011 when the downturn in Ireland was more severe than elsewhere.
The EBA may have sacrificed plausibility to uniformity of treatment – the exercise is in any event an input into a further phase called SREP, the supervisory review and evaluation process, rather than a definitive assessment of bank capital adequacy. The Irish banks, and numerous others, may of course need to generate or raise more capital but the relative worsening in their position flows from the assumptions employed and not from any ‘news’ uncovered by the EBA sleuths.