02 Dec 2011

Placing EU Banks under Undue Stress

Karel Lannoo

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This Commentary surveys the latest round of stress tests administered to EU banks by the European Banking Authority (EBA) and finds their exclusive focus on a single measure of capital, the Tier 1 capital ratio of Basel III, short-sighted. While the first two stress tests underestimated the capital needs in the European banking system, the third test risks overestimating the picture in some cases. By solely employing a 9% Tier 1 ratio, with a correction for market valuation of sovereign exposures, the overall end result is that banks with higher risk-weighted assets in embattled sovereigns need to put up more capital than those with lower risk-weighted assets in the core eurozone countries. This has the effect of unduly penalising banks that provide credit to the real economy in those member states where it is most needed.

Karel Lannoo is Chief Executive Officer and Senior Research Fellow at CEPS.