The Italian banking system is deeply troubled, according to the European Banking Authority’s latest stress-test results.
The results revealed the weakest systems include Italy, the United Kingdom, and Germany, in line with Morningstar equity analysts’ ratings of poor, fair, and fair, some of the lowest ratings among the banking systems covered.
Italian bank Monti dei Paschi di Siena was actually shown to be insolvent, with a negative fully loaded common equity Tier 1 ratio at the end of 2018 under the adverse scenario. The bank announced that it has raised a conditional €5 billion from a consortium of banks, including Goldman Sachs, Credit Suisse, Deutsche Bank, BAML, Santander, and Citigroup.
UK Banking System Appears Weak
The Royal Bank of Scotland (RBS) and Barclays (BARC) demonstrated common equity Tier 1 ratios of 8.1% and 7.3%, respectively, versus 15.5% and 11.4% starting points; these were some of the larger deltas among the banks tested.
Lloyds (LLOY) ended up with a ratio just above 10%, which we consider good. While none of the banks are likely to raise capital in the near term, the results do not inspire confidence, as a Brexit scenario was not included. The Bank of England indicated the EBA stress-test results will be taken into account when it publishes its own stress-test results for U.K. banks later this year. Broadly, the prospects appear even dimmer for substantial increases in capital returns for the banks.
German Banks Also Affected
Deutsche Bank and Commerzbank also appear weak relative to the overall European banking system, with adverse results of 7.8% and 7.4%, indicating the difficult competitive environment faced by German banks. Deutsche Bank was affected by the European Banking Authority’s inclusion of conduct risk for the first time, and this factor reduced its ratio by 220 basis points, versus its starting point of 13.2%.
We still expect Deutsche Bank to eventually have to raise about €5 billion in capital. The decline for Commerzbank was also concerning, considering the bank just disclosed that its common equity Tier 1 ratio declined to 11.5% in the second quarter from 12% in the first quarter, owing to higher pension liabilities, higher volumes of risk-weighted assets, and wider spreads of Italian debt, the bank holds more than €10 billion in Italian debt, indicating the broader risks of the Italian banking system to the rest of the European Union.
