Bank Stress Tests Won’t Affect CoCo Payments, ECB’s Nouy Says

  • ECB adopts EU plan to add non-binding ‘capital guidance’
  • Stress tests won’t be used to limit dividends or coupons

The European Central Bank will use banks’ stress-test results to shape capital guidance rather than impose binding requirements, giving lenders more leeway to pay coupons on their riskiest bonds, said Daniele Nouy, head of the ECB’s supervisory arm.

“As we said last year, we are in a steady state” when it comes to banks’ capital requirements, Nouy said at a conference in Paris on Wednesday. “This means that the requirements of last year will be split this year into a requirement part and a guidance part.”

As the capital guidance envisioned by the ECB isn’t binding, failing to meet it doesn’t automatically lead to restrictions under European Union law on a bank’s earnings distributions, including coupon payments on additional Tier 1 debt. Sabine Lautenschlaeger, Nouy’s deputy, had raised the possibility of splitting supervisory capital expectations in a speech last week.

Under EU rules, once a bank’s losses pierce the capital level comprising statutory and lender-specific requirements and its combined buffers, it must prevent money from leaving the business: dividends, bonuses and AT1 coupon payments are capped by the so-called maximum distributable amount.

When banks miss a coupon on AT1 securities, such as contingent convertibles, or CoCos, it’s gone forever, unlike a dividend or a bonus, which can both be made good when a lender’s fortunes improve. 

Stress Test

“Only the requirements are MDA-relevant, not the guidance, because there is no automaticity with transforming the guidance into a requirement,” Nouy said. “The outcomes of the stress test are expected to be in the guidance. They will not be MDA-relevant.”

The shift in policy brings the ECB’s practice into line with the European Commission’s thinking. In a note earlier this year, the EU’s executive arm said capital requirements “cannot be imposed in order to address hypothetical situations” such as those set in the adverse scenarios of stress tests. Non-binding capital guidance could be changed based on a bank’s performance in such an assessment, however.

The rules for the Supervisory Review and Evaluation Process, or SREP, based on which the ECB imposes such requirements don’t include that restriction. The ECB welcomes the commission’s clarification of the issue, Nouy said.

“I don’t imagine that the stress test -- either the baseline or the adverse scenario -- will produce something that we were ignoring before the stress test,” she said. “The stress tests are not expected to have an influence on the level of the MDA.”

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