Ireland’s two biggest banks can withstand a recession, EU stress tests show

The Republic’s two biggest banks have enough capital to withstand a recession, results of a Europe-wide tests show, but the State’s regulator says both still face challenges.

The European Banking Authority, responsible for the EU's financial stability, on Friday published results of stress tests designed to measure how well the bloc's banks could cope with reduced income and increased losses in a recession.

Both AIB and Bank of Ireland were found to have enough capital to absorb the likely fall in earnings and increase in losses from bad loans that would result from a downturn.

The authority’s figures show that AIB’s key capital ratio, that is the proportion of capital it holds relative to the amount of money it has loaned customers, was 17.48 per cent at the end of last year.

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In the worst-case scenario used by the European Banking Authority, this would fall to 11.83 per cent in 2020. The EU legal limit for this ratio is 4.5 per cent.

Bank of Ireland's key starting ratio was 13.82 per cent at the end of last year. Under the authority's worst-case scenario, this would fall to 8.93 per cent in 2020. There were 11 worse performing banks than Bank of Ireland in the tests.

Capital

While the stress tests have no “pass” or “fail” grade, the results aid regulators in deciding whether banks should raise more capital and what level of dividends they can give shareholders and the bonuses they can pay staff.

Reacting to the results, AIB said that it would not need to raise capital. Mark Bourke, its chief financial officer, argued that the outcome demonstrated the bank's resilience.

He pointed out that AIB’s key ratio had increased to 17.9 per cent in September. Mr Bourke remarked that with a continued reduction in bad debts and a growing loan book, “the balance sheet continues to strengthen and risk profile improves”.

Bank of Ireland said that its position was strong and it continued to generate capital organically. The bank’s key ratio was 13.5 per cent at the end of September.

The lender noted that the tests covered a three-year time frame with the “adverse” scenario assuming a severe economic downturn.

Challenges

Mary-Elizabeth McMunn, director of credit institutions supervision with the State's regulator, the Central Bank of Ireland, said the results showed both Irish lenders have enough capital to cope with the recession.

“While challenges remain, the ability of both banks to withstand shocks has improved compared to the last EU-wide stress test performed two years ago, with lower capital depletion and higher capital ratios in this year’s exercise,” Ms McMunn said.

British bank Barclays, with a worst-case ratio of 6.37 per cent, was the poorest performer among 48 European institutions scrutinised.

Fellow UK lender Lloyds, whose worst-case capital ratio fell to 6.8 per cent, also fared poorly.

Germany’s Deutsche also trailed the Irish institutions. The figures show that its capital ratio at the end of last year was 14.03 per cent.

This would fall to 8.14 per cent in 2020 under the adverse conditions applied by the European Banking Authority.