BoE stress tests: all you need to know

The Bank of England has released the results of its latest round of its annual banking stress tests and its semi-annual financial stability report this morning. Used to measure the resilience of a bank’s balance sheet in adverse scenarios, the stress tests measured the impact of a severe slowdown in Chinese growth, a global recession […]

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Draghi: Eurozone will decline without vital productivity growth

It’s productivity, stupid. European Central Bank president Mario Draghi has become the latest major policymaker to warn of the long-term economic damage posed by chronically low productivity growth, as he urged eurozone governments to take action to lift growth and stoke innovation. Speaking in Madrid on Wednesday, Mr Draghi noted that productivity rises in the […]

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Asia markets tentative ahead of Opec meeting

Wednesday 2.30am GMT Overview Markets across Asia were treading cautiously on Wednesday, following mild overnight gains for Wall Street, a weakening of the US dollar and as investors turned their attention to a meeting between Opec members later today. What to watch Oil prices are in focus ahead of Wednesday’s Opec meeting in Vienna. The […]

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Banks, Financial

RBS emerges as biggest failure in tough UK bank stress tests

Royal Bank of Scotland has emerged as the biggest failure in the UK’s annual stress tests, forcing the state-controlled lender to present regulators with a new plan to bolster its capital position by at least £2bn. Barclays and Standard Chartered also failed to meet some of their minimum hurdles in the toughest stress scenario ever […]

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Barclays: life in the old dog yet

Barclays, a former basket case of British banking, is beginning to look inspiringly mediocre. The bank has failed Bank of England stress tests less resoundingly than Royal Bank of Scotland. Investors believe its assets are worth only 10 per cent less than their book value, judging from the share price. Although Barclays’s legal team have […]

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Categorized | Banks

Banks: diverged fortunes

Posted on November 24, 2016

European banks look jealously at their American cousins. Recent drama about arcane Basel rules helps explain why. Europeans are trying to avoid the most onerous consequences of a post-crisis regulatory regime that exposes them to leverage rules long standard in the US.

Risk weights are at the heart of this conundrum. Weighting assets by risk allows banks to hold less capital against “safer” assets; loans against property, for instance, count as less risky than loans to businesses. Holdings of government bonds are treated as risk-free.

Leverage ratios are not risk-weighted, and simply measure assets in relation to capital. So, in the past, European banks not subject to leverage restrictions could boost returns on equity simply by hoarding low-risk, low-return assets. Their US counterparts had to seek out higher-return assets instead — hence their higher returns on equity.

The proposed rule change could reverse that. To understand why, consider the extra equity needed to add assets to the balance sheet. A European bank with a low average risk weight (simplistically, risk-weighted assets divided by the unweighted balance sheet) cannot easily add more low-risk assets without falling foul of the leverage rules. By contrast US banks are constrained by risk weights, not leverage. Adding safe assets such as Treasuries would increase their leverage but — thanks to the zero risk-weight ascribed to such bonds — not their risk-weighted capital. Where European banks do enjoy an advantage is in adding high-risk weight assets. This is not the confluence of incentives regulators or politicians were aiming for. In several European countries, they are already grappling with higher-risk loans that have soured.

But the idea that US banks will henceforth find it much easier to expand balance sheets and take market share has, predictably, not gone down well in Brussels. There will be heated debates in the corridors of Basel. But do not expect the returns on EU lobbying to be any better than the financial returns from Europe’s banks.

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