ECB: Euro Zone Banks Face FX Liquidity Risks from Wars, Cyberattacks
By Balazs Koranyi
ECB Stress Test Reveals Key Risks and Vulnerabilities
Reverse Stress Test Approach
FRANKFURT, July 31 (Reuters) - Wars, supply chain disruptions and cyberattacks are among the top risks facing euro zone banks and some could fall short of foreign currency liquidity requirements in case of acute stress, the European Central Bank said based on a stress test on Friday.
Unlike in conventional health checks when banks had to plot their responses to certain scenarios, the ECB this time told lenders to come up with the scenarios themselves in a so-called "reverse stress test," which would lower their Common Equity Tier 1 (CET1) ratio by 300 basis points.
Trigger Events Identified by Banks
"The most commonly applied trigger events included military conflicts, supply chain disruptions, including disruptions in the supply of energy, economic sanctions, macroeconomic confidence effects, political instability and cyber-related attacks," the ECB said in a statement.
Liquidity and Calculation Concerns
While banks' liquidity positions generally remained above regulatory minimum requirements under the various scenarios, the ECB did not appear content with how some banks made their calculations.
"The exercise did reveal inconsistencies in the way some banks translated shocks into capital and liquidity impacts," it said. "The ECB will follow up with the banks concerned with a view to them improving their stress-testing frameworks."
Foreign Currency Liquidity Risks
In addition, foreign currency liquidity was structurally tighter and stress would be more pronounced for some banks, which could then fall below the 100% minimum liquidity coverage ratio.
The ECB also noted that some banks may have underestimated foreign currency risks by projecting limited or no variability in foreign exchange liquidity metrics, limiting their ability to capture funding risk.
Implications for Solvency
This may be problematic, since past crisis episodes suggest a close link between liquidity and funding distress and banks' solvency positions, the ECB added.
Geopolitical and Sectoral Risks
Gulf, China, Taiwan Are Top Risks
GULF, CHINA, TAIWAN ARE TOP RISKS
A quarter of the 110 banks directly supervised by the ECB explicitly mentioned a Middle East conflict among the most relevant risks while other top scenarios included an escalation of the war in Ukraine, worsening trade ties between the U.S. and China and rising tensions over Taiwan.
Transmission Channels and Sectoral Impact
Banks assumed that risks would be transmitted via the real economy while financial markets would be a secondary, though also crucial channel.
"Military conflicts appear particularly detrimental for agriculture, accommodation and food services, while macroeconomic confidence effects and cyberattacks have a strong impact on manufacturing and transport," the ECB said.
"Scenarios depicting energy supply disruptions appear to negatively affect a wide range of sectors."
Mitigating Actions and ECB's Assessment
Management Responses
Various scenarios also included mitigating action by banks' management, including the sale of businesses, a capital increase or cutting dividends, and these measures offset a little more than a third of the capital loss, the ECB said.
ECB Skepticism Over Mitigation Measures
However, the ECB was also sceptical over some of these measures.
"In some cases, banks envisage actions that may not appear sufficiently supported by factual evidence in terms of being fully implementable," it said.
(Reporting by Balazs KoranyiEditing by Tomasz Janowski)
