1. What does the ECB’s comprehensive assessment of bank balance sheets consist of?
Prior to assuming the supervision of the largest eurozone banks on 4 November 2014, the ECB carried out a Comprehensive Assessment of bank balance sheets. The prime objective of this health assessment is to increase confidence in the eurozone’s banking system, by encouraging greater transparency, supervision independent of national circumstances and the more consistent application of prudential rules.
The Comprehensive Assessment of bank balance sheets involved several stages:
- A Supervisory Risk Assessment consisting in the massive collection of data on key risks (notably liquidity, rate, credit) aimed at assessing banks’ risk profiles, their relative positioning and their vulnerability to a number of exogenous factors.
Initial collections were carried out on the years 2010 to 2013. The ECB is expected to perform this exercise on a regular basis in the future.
- An Asset Quality Review or AQR, which examined the practices for assessing the value of banks’ assets, their provisioning procedures and their accounting procedures.
This phase also included a detailed review of credit portfolios and bank counterparty risks.
- A Stress Test simulating the effect on banks’ balance sheets of an adverse economic stress scenario, in order to verify that they have a sufficient level of capital to absorb large-scale economic and market shocks.
The stress test methodology examines the development of a whole series of risks: credit risks, market risks, risks related to securitisation products, the trend in interest rates, sovereign risks.
(see question 4 on methodology details)
2. What means were used to carry out the comprehensive assessment of bank balance sheets
The comprehensive assessment of bank balance sheets took place from November 2013 to October 2014. It required the substantial involvement of Societe Generale employees (a total of more than 800 people during the different phases of the project). A hundred or so inspectors from the ECB, EBA and ACPR (French Prudential Supervision and Resolution Authority) were involved in verifying the information provided by the Group.
All in all, for Societe Generale, the exercise resulted in the examination of more than 9 million credit lines and 500 million data, as well as the analysis of 2,300 individual credit files, over a period of nearly a year.
3. What were the conclusions of the comprehensive assessment of bank balance sheets for Societe Generale?
This very demanding exercise confirmed the solidity of Societe Generale’s balance sheet and the resilience of its diversified universal banking model, and therefore validated the quality of its risk control system as well as its accounting practices.
The asset quality review (AQR) demonstrated the quality of the Group’s balance sheet and risk management models: under this exercise, it concluded with a very limited adjustment in the value of the Group’s assets, less than 0.1% of its balance sheet total, and a theoretical correction of the Group’s Common Equity Tier 1 ratio at 31 December 2013 of -22 basis points.
From an accounting viewpoint, this review will not therefore have a significant impact on the Group’s financial statements (less than EUR 30 million before tax on profits and less than EUR 35 million in other capital items).
In prudential terms, this adjustment does not modify the Group’s ratios, both in respect of 2013 and for following years (see question 8).
The stress test has highlighted the Group’s financial solidity including under an adverse scenario. Societe Generale’s phased-in Common Equity Tier 1 capital ratio would be well above the minimum defined by the European Banking Authority (EBA) for this exercise.
In the central scenario, it comes out at 10.6% (vs. a target ratio of 8.0%) and 8.1% in the adverse scenario, well above the threshold of 5.5% defined by the EBA.
The phased-in Common Equity Tier 1 ratio takes account of the gradual implementation of the rules defined by the European CRR/CRD4 (Basel 3) regulation until their full application in 2019. From that date, regulatory requirements will focus on a non-phased in ratio. During the intermediate period, banks will apply increasingly restrictive rules on the definition of their capital until converging in 2019 with the non-phased in definition (also called “fully loaded”).
4. What is the methodology used for the asset quality review and the stress test?
The asset quality review (AQR) was carried out on 130 banks in 19 countries and involved three major phases:
- An analysis of banks’ accounting procedures and their consistency with best practices (“Processes, Policies and Accounting Review”)
- A review of credit risk, based on a review of specific files and a model for the estimation of collective provisions
- A review of market risks covering principally “CVA” (value adjustment in respect of counterparty risk for derivative instruments) and the valuation of so-called “level three” assets, which is based on internal models in the absence of an observable market for this type of instrument.
This review was carried out according to norms harmonised and controlled by the ECB.
The stress test was carried out on 123 banks in 22 countries, including 20 non-eurozone banks not subject to the AQR.
It consisted in a projection of banks’ balance sheets, according to two scenarios defined by the European Banking Authority and a specific projection methodology:
- A central scenario, corresponding to European Commission forecasts for the period 2014-2015, extended to 2016: at the end of the central scenario stress test, banks must have a minimum Common Equity Tier 1 ratio of 8%.
- An adverse scenario, with a particularly substantial severity: at the end of the adverse scenario stress test, banks must have a minimum Common Equity Tier 1 ratio of 5.5%.
- A methodological assumption whereby banks’ balance sheets are renewed under identical terms and conditions over the three years, without possible corrective measures.
For example, in the event of a crisis causing a substantial deterioration in credit conditions for individuals or companies, banks would continue, according to these assumptions, to lend at the same level and under the same terms and conditions.
5. What data and portfolios were examined for Societe Generale?
The asset quality review (AQR) exercise covered 9 million credit lines representing nearly half the Group’s risk-weighted assets, 500 million data and an independent review of around 2,300 individual files, selected by the supervisory authorities.
Given the consistent application of accounting methodologies and risk management throughout the Group, the exercise’s positive conclusions can be extrapolated to all its loan portfolios.
The stress test was performed on the bank’s entire balance sheet.
6. What was the severity of the stress test? How is it more severe than the tests in 2011 or other similar exercises carried out by other regulators?
The 2014 stress test is significantly more severe than that carried out by the EBA in 2011. This is because it covers a longer period and applies a greater shock on growth rates, particularly in Central and Eastern Europe, and on property prices. For example, the adverse scenario simulates, amongst other things, a decline of around 30% in the property market in France, of three rating notches for France, and a shock on the growth of eurozone countries of around -6.8% over three years. This stress test appears to be of a severity at least equivalent to the test carried out by the US Federal Reserve under the “Comprehensive Capital Analysis and Review” (CCAR). In particular, the shock applied to the GDP of European countries is on the same scale as that adopted in the most adverse CCAR scenario. However, the horizon of the European stress test is longer than that adopted for the CCAR.
7. What lessons can be learnt from the AQR concerning Societe Generale’s methodologies?
The analysis of Societe Generale’s accounting procedures during the initial phase of the comprehensive assessment of bank balance sheets concluded that there was proper compliance with accounting principles by the Group.
The fact that there were few adjustments resulting from the asset quality review (AQR) testifies to the rigour of the Group’s methodologies and risk management. For example, for key notions such as impaired loans and restructured receivables, Societe Generale already uses European Banking Authority criteria.
8. What is the impact of these exercises on the Group’s capital, profits and dividend policy?
The asset quality review is an exercise that is primarily prudential in nature. The work undertaken is a means of validating on a normalised basis the quality of banks’ management principles and portfolios, and identifying any provision requirements or additional value adjustments. These requirements are assessed using a normative methodology base, developed specifically for this exercise, which sometimes differs from usual banking practices and methods. In this respect, this review does not necessarily lead to a correction either in the prudential ratios or the accounting information of the banks concerned.
In the particular case of Societe Generale, the asset quality review exercise indicated a limited theoretical normative adjustment of -22 basis points on the Group’s Common Equity Tier 1 capital ratio at end-2013. This does not lead to a correction in prudential ratios at end-2013 or for following years.
In accounting terms, the methodology used by the ECB takes no account of the reality of situations specific to some countries or types of loan, which must on the other hand be incorporated in an accounting argumentation. However, the in-depth examination carried out by the regulators resulted in the recognition of value adjustments for some assets, representing a marginal amount given the Group’s size and commitments (less than 0.1% of its balance sheet at 31 December 2013).
This review will not therefore have a significant impact on the Group’s financial statements:
- less than EUR 30 million before tax on profits, or less than 1% of pre-tax profit for 2013
- and less than EUR 35 million in other capital items, or less than 0.1% of the Group’s book equity at end- 2013.
This exercise has no impact on Societe Generale’s dividend distribution policy, which remains unchanged, with a distribution objective of 50% of profits at end-2016 (excluding the revaluation of own financial liabilities and DVA).