The European Banking Authority's latest stress test shows that most of the continent's banks have resilient capital buffers and suggests they will be able to increase shareholder returns, according to analysts.

The regulator found that under a hypothetical adverse scenario, the aggregate common equity Tier 1 (CET1) ratio of the 70 banks examined would drop 459 basis points to 10.38% in 2025 from 14.97% at the end of 2022. The scenario included persistent high inflation, increasing interest rates, a severe global recession and higher unemployment.

Banks demonstrate "very good resilience" due to improved credit quality since the previous 2021 stress test and higher net interest income, Rocio Falcones, senior director at consultancy Alvarez & Marsal, told S&P Global Market Intelligence. Net interest income (NII), which is the difference between interest generated from loans and that paid out on deposits, has increased due to higher central bank rates.

Given the banks' strong capital positions and higher profits, most will be able to increase dividends and share buybacks, Fernando de la Mora, managing director at Alvarez & Marsal, told Market Intelligence.

The stress test results show improvements in European banks' capitalization and asset quality, which is supportive for the banks' capital distribution targets, Michael Christodoulou, analyst at investment bank Berenberg, wrote in a July 31 note.

Buoyed by higher NII, many lenders have announced plans for large shareholder payouts through dividends and buybacks. Banks in the stress test sample increased their return on equity to an average of 7.8% as of the end of 2022 from 1.7% two years earlier, the European Banking Authority said. The average nonperforming exposure ratio decreased to 1.6% from 2.1% over the same time period.

– Access the EBA Stress Test 2023 Excel template on CapIQ Pro via the Excel Template Library. – Access detailed capital data for NordLB, Helaba and Deutsche Bank on CapIQ Pro.

Four German banks were among the 10 lenders with the lowest CET1 ratios in the adverse scenario — DZ Bank, which serves as the central institution for cooperative banks around Germany; two regional landesbanken, Norddeutsche Landesbank Girozentrale, or NordLB, and Landesbank Hessen-Thüringen Girozentrale, or Helaba; and the country's largest private bank, Deutsche Bank AG. Topping the list is French government-owned La Banque Postale SA, which would see its capital wiped out to virtually nothing.

Nordic banks Swedbank AB (publ), DNB Bank ASA and Svenska Handelsbanken AB (publ) are among those that would retain the highest capital ratios under the stressed scenario.

The results of the stress test are used by regulators to inform decisions about individual banks' underlying capital requirements and discussions with lenders about their dividend and buyback plans. The latest test was conducted on institutions from 16 EU and European Economic Area countries, representing about 75% of EU banks' total assets.