ECB reveals the European bank solidity index SREP and the requests for 2024

Once a year, better not to abound, the ECB publishes the SREP report on the riskiness of the banking system. “Supervisory Review and Evaluation Process, or SREP for short, is the risk assessment process of banks carried out by the ECB as the supervisory body.

Specifically, SREP shows the bank’s position in terms of capital requirements and risk management. In the SREP decision, which the supervisor sends to the bank at the end of the process, key objectives are set to solve the problems identified. The bank must then “correct” them within a specified period of time.

The authorities assess the risk profile of institutions based on four facts:

• Business model: supervisors assess the sustainability of each bank’s setup, in other words, whether it has a broad range of activities or whether it focuses only on certain lines of business. A bank that focuses exclusively on shipping, for example, would be very vulnerable to a slowdown in global trade or overly generous lending to shipbuilders and must manage this risk.
• Risk management capacity: supervisors examine a bank’s organizational structure by monitoring management bodies and checking whether risks are being adequately managed.
• Capital Richness: Supervisors analyze whether a bank has a safety net sufficient to absorb losses resulting from, for example, cyber attacks on the bank’s computer system, a sharp drop in oil prices, or borrowers not repaying loans on time.
• Liquidity: supervisors test a bank’s ability to cover liquidity needs on an ad hoc basis, such as during periods of economic uncertainty when depositors may withdraw much more money than usual.

Based on these assessments, systemic banks receive a grade and a set of corrective guidance.

European banks, according to the report released today, are doing well, with the average rating unchanged and remaining at 2.6. A lower rating indicates greater soundness, and banks are divided into categories ranging from 2+ to 4. What has changed slightly, however, is the distribution among the various bands.

The share of banks with scores of 2, 3, and 3 increased, while the share of banks with scores of 2+, 2, and 4 decreased. Supervisors continued to be cautious in their assessments due to the effects of the Russian war in Ukraine, continued high inflation leading to tighter monetary policy, and the crisis of some banks in the United States and Switzerland.

It seems clear that the average is the same, but the distribution has changed, and the sign is that of a decline, quite noticeable and continuous, in the safer banks. The average does not change because the number of 2-banks has increased, but 2-2+ have declined, and this is a sign that, however, there are less robust banks.

The directions for 2024

For 2024, the ECB’s guidance is for a slight strengthening of the capitalization of the banking system. The guidance will call for an increase in capitalization reserves.

This, on the other hand, is the level of capitalization required according to the different lending activities carried out

Small banks are required to have an astronomical level of capitalization. This will limit their ability to lend.

Eventually, the consequences of the ECB’s demands for greater capitalization:

Will limit lending capacity;
will not improve the soundness of the banking system, because the increase of a few tenths of a percent does not change anything from a practical point of view.
In the end, these studies will not be of much value if, tomorrow, there is a serious systemic crisis, perhaps resulting from the bursting of a housing bubble at a time of a weak economy. Instead, they will certainly limit the availability of credit for businesses.

Moreover, restricting small banks more means penalizing those banks that most influence the real economy, but this is not a concern for the ECB.