The European Banking Authority (EBA) published today the periodical update to its Risk Dashboard summarizing the main risks and vulnerabilities in the banking sector on the basis of the evolution of a set of Risk Indicators (RI) across the EU.
You really have to critically analyse this report, as it contains mixed messages on the capitalization of banks.
On the one hand, the report opens with a positive message: “EU banks’ capital ratios further increased in Q3 2015. The CET1 ratio was 13.0%, 10bps higher than in Q2 2015.”
For sure, this is very good, CET1 ratios should go up.
Deprecating the opening line, however is this: “The quality of banks’ loan portfolios further improved in Q3 2015, but remains a concern. … The NPL ratio was lower for large banks (4.0%) and significantly higher for small institutions (21.7%). ”
High CET1 ratios offer a false sense of security if the left-hand side of the balance sheet presents inflated asset values.
Not helping is that profitability of EU banks is still low. The average RoE ‐ showing the common seasonal decline during the second half of the year ‐ decreased to 6.4% in Q3 2015.
With the stress test coming up and a deteriorating economic environment, the following summary from the report offers an ominous sign: