ASSET QUALITY REVIEW (AQR)

Abstract

In November 2013, the European Central Bank (ECB) and the European Banking Authority (EBA) have agreed on the most significant parameters for the European Banking Union with the analysis of the leading banks balance sheets in the euro zone. The first step for the implementation of European banking project is the Asset Quality Review (AQR) that must be concluded by October 2014. The aim of the ECB is to evaluate the soundness and quality of financial balance sheets of 130 lenders. It is a European transparency initiative, whose main goal is to restore the confidence of international investors in the soundness of the EU financial system. The Asset Quality Review (AQR) includes a general risk assessment of the banks and a Stress Test (ST) in order to check the resilience in case of unfavorable market conditions.

Asset Quality Review (AQR). The ECB analyzes Balance for 130 Leading European Bank

In order to fund the real economy and allocate resources, European banks have to solve some domestic and managerial issues. Therefore, the AQR is a necessary step to link the financial sector to the real economy. For this reason, the leading banks of the EU members have started to revise their budgets and strengthen their balance sheets. The national authorities are equipped with suitable structures for monitoring, research and data transmission to the ECB.

The lending institutions submitted for review will be about 130 (85% of the EU banking system), including 15 Italian banks. According to the ECB, the AQR is a strategic step to stimulate the necessary corrective measures on the balance of European banks.

The AQR is organized on three levels of analysis as shown in Table 1:

-Overall risk assessment: quantitative and qualitative supervisory activities (liquidity, leverage, funding sources) currently carried out by national authorities;

- Asset Quality Review (AQR): a detailed review of loans, securities and financial instruments;

- Final Stress Test (ST): balance will be subjected to simulated deep recession for their ability to react. 

 

Table 1: Balance analysis of European banks.

 

 

In this way illiquid assets will be reviewed, together with Contingent Convertible Bond (Coco Bond), sovereign debt and non-performing loans.

At the end of AQR, the ECB will give its rating on each national bank with the possibility to raise their capital if necessary. Governments will provide the necessary liquidity to prevent speculative attacks on their banks. Therefore, the ECB has provided for the establishment, by the European governments, of a network security with public financial resources to be used in case of necessity (public back stop).


References

BANCA D’ITALIA (2014) La recente analisi dei prestiti deteriorati condotta dalla Banca d’Italia: principali caratteristiche e risultati, Banca d’Italia (http://www.ilsole24ore.com/pdf2010/SoleOnLine5/_Oggetti_Correlati/Documenti/Finanza%20e%20Mercati/2013/07/Nota-Provisioni.pdf?uuid=1cf49f18-f87d-11e2-b0d2-9290ada7c4f9)

EUROPEAN CENTRAL BANK (2014) Asset Quality Review Phase 2 Manual, ECB, March (http://www.ecb.europa.eu/pub/pdf/other/assetqualityreviewphase2manual201403en.pdf?e8cc41ce0e4ee40222cbe148574e4af7)

EUROPEAN CENTRAL BANK (2013) La BCE da inizio alla valutazione approfondita in vista dell’assunzione delle funzioni di vigilanza, Comunicato stampa BCE, 23 Ottobre (http://www.bancaditalia.it/media/comunicati_bce/com_bce/2013/pr-20131023/PR_2013-10-23-comprehensive-assessment_it.pdf)

HENRY J. – KOK C. (2013) A macro stress testing framework for assessing systemic risks in the banking sector, ECB Occasional paper series no 152 / October (http://www.ecb.europa.eu/pub/pdf/scpops/ecbocp152.pdf)

OTTOLINI R. – UBALDI E. (2014) Liquidity Stress Test: da utili a necessari, FinRiskAlert.it (https://www.finriskalert.it/wp-content/pdf/Newsletter-5-2014.pdf)

QUAGLIARIELLO M. (2013) Dall’analisi della qualità degli attivi allo stress test europeo, Contributi Bancaria n.9 (http://www.bancaria.it/assets/PDF/2013-09.pdf)

 

Editor: Giovanni AVERSA