European banks: Headwinds limit capital build in 2018, more to come

The European Banking Authority’s Q4 2018 Risk Dashboard, published on 29 March, showed 2018 to have been a difficult year for capital generation for the European banking system as a whole, as evidenced by the decreasing CET1 ratio over the period, write Crédit Agricole CIB’s DCM solutions team.

This is certainly the result of a combination of factors, including subdued profitability, various regulatory impacts, but also banks’ dividend policies. The CET1 evolution has indeed to be assessed in light of the distance to minimum CET1 requirements, as some banks chose to prioritise dividend payments (or even share buybacks) when the buffer to those requirements is consistent with the bank’s target.

Here we focus on the regulatory headwinds.

We have analysed the full-year 2018 results of a sample of European G-SIBs to determine the key items that affected capital generation in 2018, as well as future impacts based on the following methodology:

The change in CET1 ratio year-end 2017 vs. year-end 2018 in basis points is calculated before the first-time impact of IFRS9. Hence IFRS9 appears as a separate item in the table.

Some banks report the capital movements on a quarterly basis only, which have been annualised for the purpose of this analysis. The “other” item in the table is also used as a balancing item when the sum of the reported capital impacts does not result in the year-end CET1 ratio.

The future identified impacts are not always disclosed in the results presentations. The Q&A session was therefore used as a source to find some management guidelines.

Among the peer group, half of the banks have seen their capital ratios decreasing. However, the CET1 position also needs to be seen in light of the distance to minimum CET1 requirements. Key impacts include:

UK banks have been notably impacted by litigations and pensions.

French banks communicate on the contributions to the Deposits Guarantee Scheme, with an impact ranging from -8bp to -13 bp.

Groupe Crédit Agricole and BNP Paribas have been negatively impacted by the change of approach to operational risk, which has been brought to the standard method level.

RWA movements have impacted banks across the board, in particular a sharp increase in market risk for a few banks (e.g. SG).

UniCredit is particularly exposed to the Fair Value Through Other Comprehensive Income (OCI), which reflects the evolution of the BTP spread.

In the coming years, banks will continue to face significant regulatory and accounting headwinds.

Accounting-wise, IFRS16 Leases is effective for annual reporting periods starting on 1 January 2019. Several banks have already communicated the impact, which will range from 5bp to 20bp.

The ECB TRIM (Targeted Review of Internal Models) exercise will continue to produce its effects in 2019.

EBA guidelines and calendar provisioning have been cited by UniCredit, in line with the bank’s previous communication.

Longer term, the finalisation of Basel III will affect the banks’ capital positions to various degrees. A number of banks in the peer group have not communicated on the potential impact.

In light of the future headwinds identified above, capital generation in the banking sector is likely to remain a key theme for stakeholders.