European banks are capital sound and have ample liquidity as well as improved profitability, according to the results of the 2022 supervisory audit released yesterday by the European Central Bank. However, the ECB is concerned as its findings reveal problems in the internal management of banks. The relevant audit process was carried out at a time when economic conditions and financial markets were deteriorating following the Russian invasion of Ukraine. However, rising interest rates have led to increased profitability and capital accumulation. On average, banks maintained strong positions in terms of capital and liquidity. The vast majority of them hold more capital than the capital requirements established since the previous round of supervisory reviews. In general, the ratings remained unchanged.

Andrea Enria, head of the European Central Bank’s supervisory arm, said banks have weathered the economic fallout from Russia’s incursion into Ukraine thanks to strong capital and liquidity positions, improved profitability and continuous improvement in asset quality. As a result, 24 banks were asked to raise their capital adequacy ratios to cover NPLs because they did not meet ECB requirements. The overall capital lag in terms of NPL provisions was 7 basis points of risk-weighted assets at the end of the exercise cycle. Banks that are actively addressing these shortcomings will be able to quickly reduce this new markup during 2023 without waiting for the next assessment.

Moreover, the ECB assessed the risk of over-leveraging for the first time in the context of SREP. Its purpose was to identify banks that needed to implement quality assurance measures. As a result, the ECB published quality indicators for four banks.

For the coming period, overall capital requirements and guidelines have increased to an average of 15% of risk-weighted assets, compared to 14.7% in the previous SREP cycle.

Average total capital requirements and CET1 core capital ratio recommendation increased to approximately 10.7% of risk-weighted assets from 10.4% in 2022. At the end of the third quarter of 2022 was 14.7% of assets risk-weighted.

In conclusion, the average overall SREP score in 2022 remained broadly unchanged, with 92% of the surveyed banks achieving the same overall SREP score as in 2021. The score of the remaining 8% of banks deteriorated. However, problems arose in the so-called internal management of the banks, since, according to the ECB, “the relevant findings raised concerns about the effectiveness and composition of the governing bodies, their collective suitability and the supervisory tasks entrusted to them.

The ECB also found that many banks are under-resourced across all their control functions such as risk management, compliance and internal audit. The war in Ukraine has also led to an increase in operational and IT cyber risks, prompting banks to address weaknesses in their outsourcing mechanisms and IT security and cyber resilience foundations.