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What can we learn from the results?

The ECB’s Comprehensive

Assessment

Strategy&

Executive summary: Key findings and implications

Confidential property 1

On October 26, the European Central Bank (ECB) published the results of its Comprehensive Assessment of the 130 largest banks in the Eurozone, consisting of an Asset Quality Review (AQR) and a Stress Test. The Stress test was executed together with the European Banking Association (EBA) and included another 20 non-Eurozone banks

Strategy& analyzed the published results and combined them with available bank- and country-specific information

On first sight, the impact of the Comprehensive Assessment is relatively limited, with €7Bn additional capital to be raised across 11 banks with outstanding shortfalls, although it is fair to say that so far reviewed banks have raised an aggregate €40Bn in 2014, most likely also driven by the pressure of the review

The aggregate capital depletion identified in the Comprehensive Assessment amounts to €263Bn — but because these are prudential rather than accounting findings, only a portion of this will be reflected in banks’ balance sheets

Banks with high capital depletion are typically from countries highly affected by the sovereign debt crisis, are small, had a low credit rating, and often face restructuring requirements due to received state aid — this highlights that, without a convincing and profitable business model, state aid alone is insufficient to render banks stable

Banks with positive results are typically based in strong economies, are large or part of a larger group, and have been exposed to data-driven supervision — suggesting that data quality was an important driver of findings

In general, markets were expecting larger banks to fail and the overall shortfall to be higher, raising the question of whether the exercise is perceived as sufficiently stringent by investors

The Comprehensive Assessment could lead to a fallacy for those banks that are sufficiently capitalized but have an intrinsically weak(er) business model to lose momentum for reform and improvement

Going forward, banks should adapt their business model and risk management to the changing environment of bank supervision, which is likely to be more standardized and data driven

28 October 2014

Strategy&

To enhance banking transparency

To restore confidence in European banks

To repair banks and increase capital

To prepare for the ECB’s new supervisory role

which begins November 2014


150 Banks in 25 Countries

Source: Note on Comprehensive Assessment, October 2013, Strategy& analysis

130 participated in the full assessment,

including the Asset Quality Review (AQR)

Additional 20 banks participated in the

European Banking Authority (EBA) stress test

Portfolios were selected based on contribution

to risk

Scope

Objectives

Description of assessment

The AQR in particular was a very extensive

review involving many resources at the

national competent authorities (NCAs) and at

the reviewed banks

Total costs are estimated at ~€0.8–1.0Bn

Costs

Cyprus

Malta

Asset Quality Review (AQR)

and stress test

Stress test only

Not in scope of CA

28 October 2014

Overview of the European Central Bank’s (ECB’s) Comprehensive Assessment (CA)

Strategy&

The ECB Comprehensive Assessment consisted of three components: an AQR, a stress test and the join-up

Confidential property 3 28 October 2014

Components of Comprehensive Assessment

Asset Quality Review

(AQR)

Stress Test

Point-in-time assessment of the accuracy of the carrying value of banks’ assets as of Dec. 31, 2013

This review involved uniform methodology and harmonized definitions for all banks, in line with capital requirements regulations and directives (CRR/CRD IV)

Banks were required to have a minimum Common Equity Tier 1 (CET1) ratio of 8% after the AQR — compared to 4.5% under Basel III requirements

Forward-looking examination of the resilience of banks’ solvency under two hypothetical economic scenarios — a baseline and an adverse scenario

The review incorporated bank calculations and centrally defined requirements in order to ensure sufficient conservatism in projections

Banks were required to have a minimum CET1 ratio of 5.5% after the adverse scenario — compared to 4.5% under Basel III requirements

Source: Aggregate report on the Comprehensive Assessment, AQR, stress test and Join-up Methodology, Strategy& analysis

Join-up

Integration of the AQR results into the stress test for each bank according to calculations set by the ECB

Adjustment of risk parameters, valuation adjustment for fair value assets and implementation of DTA thresholds in the stress test

Strategy&

The assessment found that €263Bn had been lost in capital impact on top of a €49Bn drop since the CRD IV phase-in


Capital depletion in comprehensive assessment Aggregated across 130 AQR banks in billion Euro

28 October 2014

1) Tier 1 refers to core tier 1 capital under CRD III, and CET1 refers to common equity tier 1 capital under CRD IV – average weighted by RWA

Source: ECB/EBA disclosure templates, Strategy& analysis

Final

CET1

229

ST

impact

8%

threshold

995

CRD IV

phase-in

49

-5%

Tier 1

capital

1,044

AQR

impact

34 -3%

733

Starting

CET1

-22%

Tier1 /

CET1%1 12.4% -0.6% 11.8% -0.4% -3.0% 8.4%

Total

Capital

CA impact:

€263Bn

The total CET1 capital impact found was €263Bn, of which €229Bn resulted from the stress test (incl. RWA effect) and €34Bn from the AQR

On average, banks remain well above the 8% AQR threshold, even after the stress test, but individual banks have fallen below

The average stress test impact is larger than the AQR for two main reasons

– The AQR reflects current market value — the stress test reflects a performance under a hypothetical adverse scenario

– The stress test covers the entire balance sheet, whereas the AQR covers only selected portfolios

The drop in capital from the CRD IV phase-in exceeds the AQR impact, highlighting the impact from Basel III on bank capital

Comments

Strategy&

Bank Shortfall (€Mn) Assets

€Bn

State

aid Country

Monte dei Paschi di Siena 199.1 Italy

Banco Comercial Português 82.0 Portugal

Österreichischer Volksbanken 40.6 Austria

Permanent tsb 37.2 Ireland

Banca Carige 37.0 - Italy

Dexia N.V. 222.9 Belgium

Hellenic Bank 6.4 - Cyprus

Banca Popolare di Vicenza 45.2 - Italy

Banca Popolare di Milano 49.4 Italy

Nova Ljubljanska banka 12.5 Slovenia

Nova Kreditna Banka Maribor 4.8 Slovenia

Another 14 banks have failed, but do not have to raise additional

capital, due to restructuring efforts (2 banks) and sufficient capital

being raised since Jan. 2014 (12 banks)

In total, 11 banks have failed the assessment with additional 14 “technical failures”

5

List of failed banks in CA Banks that have to submit a capital-raising plan

The direct capital implications from the CA are limited. Failed banks are required to raise an additional €7Bn or a mere 0.7% of total CET1 capital included in the exercise

Capital injections of €25Bn — equal to gross shortfall — to be distributed among 25 banks (including technical failures)

Characteristics of the failed banks:

– Size: Mostly smaller banks failed. Average total assets of (technically) failed banks is €59Bn, compared with overall average of €170Bn

– State aid: Of the 11 failed banks, 8 have received state aid since 2008. Of the 14 technical failures, 7 received state aid

– Country: Most failed banks were located in Italy, with another 5 Italian banks in the technical failure group

Source: State aid: European Commission approvals and internet search, ECB/EBA disclosure templates, Strategy& analysis

818

31

34

682

682

276

339

1,839

855

865

1,168 1,168

4,246 2,107

Capital to

be raised

Total shortfall

Technical

failures

28 October 2014

Comments

Confidential property

Strategy&

The impact from the stress test is significantly higher than in the previous EBA stress test across most countries


Comments

Note: The country averages are based on the 72 that have participated in both stress tests. The relative capital impact is estimated relative to the AQR-adjusted CET1%


Comparison of 2011 EBA stress test to CA 2014 Average relative CET1 impact including risk-weighted assets (RWA)

The comprehensive assessment was more severe than the previous EBA stress test

– CA includes 3 years of stress, compared to only 2 years in the 2011 stress test

– More severe scenarios have been used, for example: funding and sovereign shocks

– Bank calculations have been centrally reviewed and challenged improving the quality of the results

Previous outliers are now more in line with the majority of countries

The significantly higher financial impact in combination with the depth of the review, especially the inclusion of an AQR in parallel, adds to the credibility of the results

28 October 2014

NO -8% 0%

45% BE 8%

47%

PT 29% 49%

SI 26% 67%

CY 24% 79%

GR 37% 90%

SE -5% 11%

DK -10% 18%

UK 26% 21%

HU -11% 25%

ES 2%

14%

MT 1% 17%

NL 11% 22%

FR 10% 23%

LU -11% 25%

FI 5% 27%

DE 25% 32%

AT 11% 36%

IT 13% 37%

IE 120%

2011 stress test 2014 stress test

Stress-test-only

countries: starting

position not

adjusted by AQR

Strategy&

On country level, three groups can be distinguished with regard to the impact of the comprehensive assessment


-0.2

0.1

22.5

0.10.20.1

49.2

18.5

3.71.2

46.9

10.9

47.2

13.015.2

8.0

1.43.2

22.5

1%

11%15%15%

20%

26%27%

35%

45%48%

89%90%

-5

0

5

10

15

20

25

30

35

40

45

50

-10%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Total CET1

Capital impact

Average relative

CET1 capital impact

PT

52%

SI

67%

CY GR FR

22%

NL

26%

FI LU DE

32%

AT IT

42%

IE BE MT EE LT ES

15%

LV SK

Comprehensive assessment impact per country

Total CET1 capital impact Average relative CET1 impact

Source: ECB disclosure templates, Strategy& analysis

Least impacted Average Most impacted

Strategy&

The countries most impacted by the CA are by and large the same countries that suffered most in the financial crisis


Impact per country

.


Comments

The countries most affected had also suffered in the financial crisis

– Sovereign debt crisis countries, such as Greece, Italy, Portugal, Ireland, Cyprus, and Slovenia

– Belgium, which had bailed out several banks during the financial crisis

The results of the comprehensive assessment are positive for 7 countries

– Spain and France — performance in this data-driven exercise seems in line with banking supervision in the past

– Smaller countries with above-average GDP growth, such as the Baltic states, Slovakia, and Malta

Countries with an average impact from the CA include Germany, Austria, the Netherlands, Finland, and Luxembourg

In the countries where AQRs were not conducted, banks had a lower CET1 impact, in spite of the relatively smaller impact from the AQR

28 October 2014

Average impact on CET1% as

percentage of starting CET1%

CA < 25%

CA 25–40%

ST only 25–40%

CA > 40%

ST only < 25%

Not in CA or ST

ST only > 40%

Cyprus

# # of failed banks

3

Malta

1

2 1

1

1

3

1

9

1

2

Strategy&

The sovereign bond price development was a good predictor of the outcome of the Comprehensive Assessment


Comments

There is a positive relationship between government bond yield and CA impact — with only Spain as an outlier

Countries that spent a higher percentage of their GDP supporting banks showed higher impact in the comprehensive assessment

This relationship can be explained by two factors:

– Stress test scenarios for countries with weaker economics have been more adverse

– The sovereign debt crisis affected the banking sector of most of these countries, and the banks have not fully recovered from the crisis

• The analysis underlines the importance of the European Banking Union’s objective: to disentangle the credit quality of banks from their sovereign bond positions

1) Average of the government bond 10-year index yield in 2013; Li, LU, LA, MA and SL based on one ore more single bonds with 10-year maturity; CY based on single 6-year

maturity bond; IE, and SI based on last 10 months of 2013; LI based on Q1 2014; MT based on last 5 months of 2013: LT based on Q2 2014

Source: Bloomberg, ECB/EBA disclosure templates, Strategy& analysis

Relation with government bond yield Average relative CET1 impact vs. government bond yield

Size indicates % of GDP spent to support banks

28 October 2014

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1% 7% 6% 5% 4% 3% 2% 0% 12% 11% 10% 9% 8%

Rela

tiv

e c

ap

ital im

pact

Bond yield1

SK

SI

PT

NL MT

LV

LU

LT

IT

IE

GR

FR

FI

ES

DE

CY

BE

AT

Strategy&

The CA is a highly data-driven exercise; conservative assumptions are applied in case of poor data quality

Banks that have their data systems better prepared for such requests are expected to have lower findings

Data-driven supervisors implicitly also encourage banks to improve their data capabilities and meet more rigorous standards

Supervisors are considered data driven when they apply frequent and in-depth (off-site) data analyses (for example, driven by an internal credit register), when they can adjust the bank’s accounting numbers, or when they impose standardized reporting requirements

This implies that the CA impact reflects the banks’ data quality in addition to their asset quality

Banks subject to data-driven supervision have been affected less, highlighting the relevance of data quality


Comments

1) Data index is based on: intensity of off-site data analyses, formal authority of supervisor, internal credit register, standardized reporting requirements

Source: IMF reports on quality of banking supervision, IAS Plus Website, EBA website, ECB/EBA disclosure templates, Strategy& analysis

Relation with data-driven supervision Average relative CET1 impact vs Data index1

Fast-growing

countries

28 October 2014

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

3 4 5 6 7 8 9 10

Rela

tiv

e c

ap

ital im

pact

Data Index1

SK

SI

PT

NL MT

LV

LU

LT

IT IE

GR

FR FI

ES

EE

DE

CY

BE

AT

Strategy&

Credit ratings are highly related to bank failure and CA impact, especially for speculative-grade banks


1) Fitch LT Issuer default rating. if ratings were not available for a group-subsidiary, then group rating was applied unless the group was not a bank or not located in Europe

Source: Bloomberg, ECB/EBA disclosure templates, Strategy& analysis

Comments

Credit rating is correlated to relative capital impact, and also correlated to the probability of bank failure

The speculative-grade banks (those with ratings of B+ or lower) appear to follow a high-risk, high-return strategy. They had above-average ROA in 2013, 75% of them have received state aid in the past, and they have raised a total of €11Bn in 2014 — with a remaining shortfall of €2.7Bn

Whereas the average relative capital impact is comparable across the investment-grade banks, the probability of failure is higher for lower-rated banks

These bank failures are mainly driven by the stress test impact, suggesting that the rating captures a bank’s resilience in changing market circumstances

53%

28%26%

BB+ / CCC A / BBB- AAA / A+

Starting

CET1% 12.7% 11.0% 11.0%

Relative

Capital

Impact

# banks 29 20 33

% banks

failed per

rating cluster 3% 18% 50%

Relation with bank credit rating Average relative CET1 impact vs credit rating1

Investment grade Speculative grade

28 October 2014

Strategy&

Banks that are under restructuring due to received state aid have higher findings than other banks


Relation with state aid received Average relative CET1 impact vs. state aid

Comments

Almost half (47%) of all in-scope banks had received some form of state support. This increases to 51% if group subsidiaries are not considered separate banks1

Findings are highest for banks that received state aide and are under restructuring - this highlights that, without a convincing and profitable business model, state aid alone is insufficient to render banks stable

Banks that have received state aid since 2008 and did not have – or finalized – restructuring requirements have comparable results to banks that did not receive state aid

However, these banks also have the lowest starting CET1%, suggesting that state support was not used to raise the capital buffer

1) If banks are excluded that: I) are subsidiaries of in-scope banks, ii) are subsidiaries of non-banks, or non-European companies, then 54 out of 106 banks received state aid

Note: State aid refers to banks which have received bank-specific government support since 2008, excluding general guarantee schemes set up in certain countries,

Restructuring refers to banks which are currently implementing a restructuring plan approved by the European Commission

Source: ECB Aggregated report on the comprehensive assessment, European Commission approvals and internet search, ECB/EBA disclosure templates, Strategy& analysis

27.5%25.3%

43.4%

State aid -

under

restructuring

State aid - no

restructuring /

restructuring

completed

No state aid

received

Starting

CET1% 12.0% 11.3% 12.2%

# banks 28 68 34

% banks failed

per cluster 32% 18% 15%

Relative

Capital

Impact

28 October 2014

Strategy&

Large banks and their subsidiaries have substantially lower CA adjustments than small and medium sized banks

The AQR impact is higher for small and medium sized banks

There are three possible reasons for the relation between size and CA impact

– Access to capital markets may be restricted for small and medium-sized banks, especially when they are also relatively small in their home country. Most small non-subsidiary banks have ratings of BBB+ or lower

– Risk management may be less developed at smaller banks due to scale advantages in building these capabilities

– Large banks have scale advantages in adapting to changes in the regulatory environment

Small and medium sized banks were most affected, except for small subsidiaries of groups — which performed best


Comments

1) Subsidiaries of larger groups

Source: IMF reports on quality of banking supervision, IAS Plus Website, EBA website, Strategy& Analysis, ECB/EBA disclosure templates, Strategy& analysis

Relation with bank size Average CET1 impact vs bank total assets

Relative

Capital

Impact

# banks 19 46 43

27.2%

43.3%44.2%

17.9%

Medium

banks

Small

banks

Small

Subs1

Large

banks

Starting

CET1%

% banks

failed in size

cluster

0%

11.5% 19.2% 11.2%

30% 9%

22

36%

12.6%

Bank

Assets

<€35Bn €35 - €100Bn > €100Bn

28 October 2014

Strategy& Confidential property 14

1) Based on a Goldman Sachs survey among 125 institutional investors in Sept. 2014.

Source: Bloomberg, Banks listed as expected to fail are derived from the Goldman Sachs survey (Sept. 2014), Credit Suisse (Italian Banks) Feb. 2014, NBG securities on

(Greek banks ), CEPS Acharya &Steffen Jan ’14, Nomura (2014) and newspaper coverage, ECB/EBA disclosure templates, Strategy& analysis

Comments

Markets were expecting larger banks to fail and the overall shortfall to be higher, raising the question whether the exercise is perceived as sufficiently stringent by investors

According to a survey by Goldman Sachs among investors, markets were expecting a gross shortfall in capital between €75Bn and €91Bn — excluding an assumed aggregate capital raised of €47Bn in the first 9 months of 2014. The expected net capital shortfall was between €28Bn and €51Bn1

In contrast, the gross capital shortfall identified in the CA is €25Bn, which results in a net shortfall of €7Bn after net capital raised in 2014

The banks that were expected to fail but passed the CA are substantially larger than the failed banks, suggesting that the assessment took bank size (“too big to fail”) into account

Failed banks compared to investor expectations

Legend

Real failures

Technical failures

28 October 2014

Cooperative Central Bank

Eurobank

National Bank of Greece

Monte dei Paschi di Siena

Veneto Banca

Banco Comercial Português

Banca Popolare di Vicenza

Banca Popolare di Milano

Banca Popolare di Sondrio

Piraeus Bank

Banco Popolare

HSH Nordbank

Banco Popular Español

Raiffeisen Zentralbank Österreich

Commerzbank

Alpha Bank

Banca Carige

Hellenic Bank

Permanent tsb

Bank of Cyprus

Österreichischer Volksbanken

AXA Bank Europe

Münchener Hypothekenbank

Credito Valtellinese

Nova Kreditna Banka Maribor

Dexia

Nova Ljubljanska banka

Banca Popolare dell'Emilia Rom.

Liberbank

Caise de refinancement de l’habitat

Expected, but passed

# Banks 11 14 5

Avge CET1

impact -78.3% -72.3% -29.8%

Net capital

raised €13.8Bn €4.7Bn €0.1Bn

Net

shortfall €3.6Bn €3.2Bn -

Avge total

assets €78.7Bn €46.4Bn €207.7Bn

Investors expected 5 additional banks to fail. The actual total net shortfall of €7Bn compares to the expected €51Bn

Unexpected fails Expected fails

Strategy&

Findings for individual banks may lead to additional capital needs or affect banks’ operations in various ways


Implications for banks based on results

Source: Strategy& analysis

Sustainably profitable business model No convincing business model

Positive

results

Opportunity to leverage strength

Use increased transparency to attract

funds to fuel growth opportunities

Capitalize on M&A opportunities

Roll out superior organizational forms

and processes to other jurisdictions

Continue to rethink business model

Positive results might provide time to

fix underlying issues. It is important to

keep the momentum

Revaluate risk-return for specific

business areas, given regulatory

scrutiny and capital demands

Negative

results

Explain the results and fix issues

Develop clear storyline for the markets

Leverage key insights from interactions

with the supervisor for fixing issues

Develop clear action plan to address

identified shortcomings

Manage the damage

Practice active stakeholder

management

Consider scenarios to isolate most

affected loans / portfolios

Focus on client and talent retention

Banks are prone to

two misconceptions

Lack of repair is

enforced by CA

False positive

signal reduces

urgency of change

28 October 2014

Strategy&

The CA has provided more transparency on the quality of the banks, but there are also some limitations


Benefits Limitations

Evaluation of the Comprehensive Assessment

28 October 2014

Enhanced transparency of banks’ asset quality

across the eurozone and basis for

harmonization of bank supervision

Establishes AQR as the basis for more

consistent view of non-performing exposures

and significant increase in NPE stock

More credible than previous stress test with a

more severe scenario and strong central quality

control resulting in a significantly higher impact

Enhanced insight for bank supervisors in

portfolio-specific characteristics due to thorough

assessment of loan classifications and

provisions

The exercise has unearthed a number of data

quality issues; banks are incentivized to

improve their data management capabilities

Findings do not lead to any judgment about the

solidity of the underlying business models of

individual banks

The CA does not provide any guarantee for

performance of the banking sector going

forward, as some types of risks have not been

stress-tested (e.g. liquidity, strategic and non-

financial risks)

Impact on bank capital was lower than

expected by some market participants and only

the banks that failed can be forced to increase

their capital

Results depend on the specific methodology

chosen for the AQR, on national regulation

(such as the treatment of tax credits) and by the

assumptions in the stress test


Strategy&

Based on the CA, there are five focus areas where banks should invest to build or enhance their capabilities


Set up advanced data management and systems

Enhance loan-level and aggregated data

Include data insights in decision making processes

Stress testing

Data systems

Integrated

approach

Underwriting

culture

Integrate strategy, finance and risk more effectively

Incorporate funding and liquidity in investment

decisions

Create and enhance internal capabilities for

managing stress-testing models and mechanics

Run testing models between official stress tests

Change underwriting culture, moving from

collateral focus to cash-flow-driven analysis

Adapt policies and procedures to facilitate cultural

transformation

Increased cost of poor data

quality due to change in

supervision approach

Poor strategic decision making

due to insufficient insight in risk

and finance aspects

Increased scrutiny on bank-

executed stress test leading to

strict adjustments

Supervisory focus shifting

away from collateral-driven to

cash-flow-driven underwriting

Risks / challenges Improvement levers

Key capabilities that banks should develop

28 October 2014

Portfolio focus

Identify performance indicators

Include visibility assessment of performance in

strategic decision making

Higher capital required for

assets or countries where data

does not reflect performance


Strategy&

About the authors


Dr. Peter Gassmann is a partner with Strategy& based in Frankfurt and Dusseldorf and the global leader of of the firm's financial-services practice. He also co-leads the firm’s global risk, finance, and regulation platform supporting clients to build holistic risk, liquidity, and capital management capabilities in view of the changing business and regulatory environment.

Dr. Philipp Wackerbeck is a partner with Strategy& based in Munich and a member of the financial-services team, for which he co-leads the firm’s global risk, capital, and regulations platform. He has advised various banks, regulators, central banks, and supervisory authorities and has been leading various bank restructuring programs in Europe, the U.S., and the Middle East for many years.

Jeroen Crijns is a senior associate with Strategy& based in Amsterdam and a member of the European financial-services team. He is an expert in the area of risk, capital, and regulation for the banking and insurance industry and has led the study about the results of the ECB Comprehensive Assessment.

Dr. Christel Karsten is an associate with Strategy& based in Amsterdam and a member of the European financial-services team. She is an expert in the area of risk, capital, and regulation for the banking and insurance industry and has co-led the study about the results of the ECB Comprehensive Assessment.

28 October 2014

The following people also contributed to this analysis: Julian Biegmann, Willem Giebels, Andreas van Braam, Erwin Hieltjes, Nina Straathof and Margret Venneboerger

Strategy&

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