According to a recent declaration by the European Union’s principal banking authority, the vast majority of the bloc’s major financial institutions would be impervious to capital increases, even when faced with an absolute worst-case scenario.

This strong affirmation follows extensive Stress testing, revealing the extraordinary resilience of EU banks more than ten years after the global financial crisis.

The findings

The latest round of Stress Tests, conducted by the European Banking Authority (EBA), aimed to ascertain how well prepared the banks were to withstand substantial, yet believable, crises.

The results of these tests depicted a rather positive outlook. Out of 70 top banks scrutinized, a mere trio might find themselves grappling with minimum capital levels when faced with a nightmare scenario.

This hypothetical crisis was not a child’s play, either. It envisioned an economically disastrous combination of blows to the EU’s output, employment, and property prices in a milieu of escalated inflation and interest rates.

With an overall potential loss estimated at €500bn over three years, only three financial institutions would find themselves in turbulent waters. That’s quite a feat, wouldn’t you say?

What’s more, even if the harshest gusts from the crisis storm were to strike by 2025, a significant number, approximately 37, would merely face payout limitations to their shareholders.

The stress tests took into account a cumulative 6% dip in EU GDP over the span of three years, along with a 5.7% hike in unemployment rates across the EU, persistent inflation, and a property market collapse. Yet, the banks emerged robust from this financial tempest.

The hard truth

Consider this: the 70 banks tested would hypothetically pivot from a combined annual profit of €128bn in 2022 to a staggering loss of €139bn the following year, and then bounce back to significantly lower profits in the subsequent two years.

Yet, the overall robustness of the EU’s banks remains largely unaffected. There is something to be said about this display of resilience.

This resilient nature is not confined to the EU, though. Banking regulators in the UK and US recently delivered similar stress tests with comparable results. Both countries’ financial institutions demonstrated an equally commendable ability to withstand economic shocks.

It’s important to note, however, that these tests primarily concentrated on banks’ capital, omitting the liquidity stresses blamed for a string of US bank failures earlier this year.

Interestingly, France’s Banque Postale turned out to be the least resilient, with its capital potentially depleted in an EBA stress scenario. But hold your horses – it’s not as bad as it sounds.

The bank reasoned that this vulnerability was due to the acquisition of insurer CNP Assurances, which made up 60% of its balance sheet, thereby making it susceptible to certain market shocks.

The EBA and the European Central Bank also reviewed unrealised losses borne by Europe’s banks within their government bond portfolios. These losses, though triggering concerns, amounted to a manageable €75bn.

Bottomine is the resilience of EU banks is commendable. They have successfully weathered real-life adversities, including the Covid-19 pandemic, geopolitical instability, and recent turbulence within the US regional banking system.

The outcome of the 2023 stress tests provides a mirror to the preparedness of European banks and signals their strong ability to face future challenges.