ECB creates two indicators to monitor bank vulnerabilities — Cyprus Mail
The European Central Bank has developed two new indicators to monitor vulnerabilities among euro area banks between regular stress tests. They are intended to help supervisory authorities assess whether lenders can withstand future losses and remain profitable during an economic downturn, Cyprus Mail reports.
The indicators were presented in a new ECB working paper. They will update the assessment of risks in the banking sector quarterly, using data from EU-wide solvency stress tests conducted every two years by the ECB and the European Banking Authority.
Two dimensions of banking resilience
The Stress Vulnerability Index, or SVI, assesses how much banks' capital could decline under an adverse economic scenario, including the risk of significant loan losses. The Profitability Vulnerability Index, PVI, measures pressure on banks' current income and their ability to build capital independently through interest and operating profits.
The SVI focuses primarily on potential capital losses due to credit risk and changes in risk-weighted assets under adverse scenarios. The PVI reflects the impact of current economic conditions on income, particularly net interest income — the difference between interest a bank receives on loans and its expenses for deposits and other funding.
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A guide for decisions on buffers
The researchers found that both indices rose during the global financial crisis and the European debt crisis. At the same time, the profitability indicator increased more sharply during periods of acute financial stress. The indicators can move in different directions: the risk of future capital losses may decline amid weak profitability, while concerns about a future recession may intensify against a backdrop of improving current income.
The ECB noted that these differences may help determine when to introduce or strengthen precautionary measures, maintain them, or remove them. The paper describes a recent divergence: the SVI remained somewhat elevated despite improved profitability reflected in the PVI. According to the authors, this supports a cautious approach to maintaining existing capital buffers, which banks hold to absorb losses and continue operating during difficult periods.
Both indicators also demonstrated a strong statistical relationship with the likelihood of banks receiving state support after the global financial crisis — both in recapitalisation programmes for individual banks and in nationwide schemes. According to the researchers, this indicates that the indicators may help identify vulnerable banks and countries for decisions by supervisory and financial stability authorities.
