Introducing the “Leverage Ratio” in Assessing the Capital Adequacy of European Banks

The European Banking Authority (EBA) disclosed the effect of losses in a stress test on bank capital ratios on 29 July 2016. We assess the capital adequacy of these banks based on these disclosures and using two supervisory approaches (the approach used by the EBA in the Asset Quality Review in 2014 and the methodology used by U.S. supervisors in the Comprehensive Capital Analysis and Review (CCAR) in 2016) and a market based approach. The two supervisory approaches yield an ordering of banks with respect to their capital shortfall (or surplus) that is negatively correlated. The CCAR 2016 approach, however, ranks banks similarly as the market based approach. The capital shortfall differences between the approaches can be attributed to (i) different prudential thresholds applied to capital ratios, (ii) different loss projections under the stress scenario, and (iii) the difference between market and book values of bank equity.  The differences are particularly large for banks in France, Germany, Italy, Spain and the United Kingdom.

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