For the fifth year running, S&P Global Ratings presents its risk-adjusted capital (RAC) ratios for the top 50 European banks that we rate. This year, we rank the banks by total adjusted capital (TAC), which we use in our risk-adjusted capital framework (RACF), excluding the deduction we make for investments in insurance subsidiaries.

Capitalization at the 50 banks, as measured by our RAC ratio, in our view slightly decreased in 2018 for the first time since the 2008 financial crisis. The small deterioration in 2018 from the previous years' improvement is due to an average negative 20-30 basis points (bps) impact related to the implementation of IFRS 9 from 2018. It also stems from the prolonged environment of low interest rates that is weighing on internal capital generation with banks tending to balance the squeeze on margins by increasing lending volumes. Given that we believe this trend will continue in the next few years, we expect RAC ratios to remain relatively stable in the next 18 to 24 months.

We forecast an average RAC ratio of 10.3% for the 50 banks over the next 18 to 24 months. In 2018, the RAC ratio for the top 50 decreased on average to 10.0% from 10.1% at end-2017. As a result, we now see capital adequacy as a ratings strength for 23 of the 50 rated banks in Europe, up from 17 five years ago.

Finalization Of Basel III: The Impact On The Regulatory Ratio Is Expected To Be Material, But Unlikely To Change Our View About Capitalization

In December 2017, the Basel Committee published the final Basel III framework that complements the initial phase of Basel III reforms published in December 2010 and updated in June 2011. While the initial phase of reforms substantially improved the quality of bank regulatory capital, increased the scope of risks captured, and revised some areas of the risk-weighted capital framework, the final phase of reforms aims to reduce the excessive variability of risk-weighted assets (RWAs). Once implemented, this will lead to regulatory capital ratios being more comparable, in our view. We believe the final standard is a big step in reducing the variability of RWAs and increasing the comparability in the regulatory capital ratios—which were the key objectives of regulators. That said, we see a risk of some jurisdictions deciding not to implement all of the final Basel III framework. This would undermine comparability and efforts to restore market confidence in banks' capital ratios. Below is a snapshot of the main changes introduced by this final phase of reforms regarding the calculation of regulatory capital ratios.

Implementation of the final reforms, which will take place in 2022 with the output floor being phased in until 2027, is generally expected to weigh on the capital ratios of European banks and a much higher impact is expected than for banks in other regions. Based on the European Banking Authority study "Basel III Reforms: Impact Study And Key Recommendations, August 5, 2019" the weighted average impact on fully phased-in common equity tier 1 (CET1) capital ratios of the 189 European banks included in the sample is expected to be around -290 bps. This impact is largely driven by large banks (see table 1; most if not all of the top 50 European banks in this article are considered as large banks). This is much higher than the expected -40 bps for American banks. The zero bps for banks in the rest of the world, disclosed in the latest Basel III monitoring report published by the Bank of International Settlements in March 2019, masked large variations, with many large Japanese banks likely to also be materially negatively impacted due in part to their extensive use of internal models. The expected large impact on the capital ratios of European banks mainly comes from their current extensive use of internal ratings-based (IRB) models and relatively low risk weights on some assets like mortgages and retail exposures, for example.

Table 1

Those estimates do not reflect the finalization of the market risk framework published in January 2019 and assume static balance sheets. Assuming (conservatively) that regulators leave the Pillar 2 requirements and EU-specific buffers unchanged, the Tier 1 minimum required capital amount for large banks is expected to increase by 25% on a weighted average basis and with the output floor delivering most of the impact (see table 2). While the expected impact differs based on bank size, it also varies by bank business model. Those reforms are expected to impact cross-border, local universal banks and mortgage banks the most.

Table 2

This large estimated impact could potentially decline before implementation of the reforms. That's because banks will likely take further action until 2022 and, to a lesser extent, because of the Targeted Review of Internal Models (TRIM) investigation. TRIM is a multiyear project to ensure that capital requirements for banks using internal models are calculated correctly, consistently, and comparably. This project was launched in 2015 and should be concluded in early 2020. So far, the exercise has revealed common and critical shortcomings in credit models, data quality, and market risk calculation such as the calculation and definition of probability of default (PD) as well as the calculation loss given default (LDG). This is leading to some supervisors to take decisions that will potentially marginally decrease the benefits from internal models and therefore ultimately reduce the gap that the output floor will try to bridge. The impact on regulatory capital ratios of TRIM and implementation of the final Basel III reforms is unlikely to affect our view about the capitalization of banks. That's because the foundation of our capital analysis remains based on our own calculation of RAC.

Capitalization Continues To Vary Widely By Country And Bank

The small decrease in the RAC ratio in 2018 followed years of capital building. Excluding the IFRS 9 impact, the RAC ratio would have increased by an average of around 10-20 bps. We see this trend confirmed by our combined assessment of capital and earnings and risk position--which allows us to refine our standardized capital assessment by considering whether our sectorwide assumptions are appropriately capturing individual banks' risk profiles. The combined assessment points to ratings strengths for 23 banks, up from 21 a year ago and 17 five years ago.

Even though capitalization has slightly deteriorated in most of the countries in our sample, we continue to see large differences across countries and banks, with the RAC ratio ranging from 3.8% to 20.1% for the 50 banks and with 23 banks being more than 200 bps away from the median. The highest ratios are mainly in countries where banks benefit from supportive economic conditions, mainly Switzerland, Germany, and the Nordic countries, resulting in low credit losses, and generally good access to cheap funding sources. The RAC ratios are on average the lowest in southern European countries where banks are operating under tougher conditions, although gradually improving. We don't expect capitalization to grow significantly for the 50 banks in coming years. Specifically, we think the RAC ratio will increase between zero and 50 bps on average over the next couple of years as banks in several countries continue building up capital, mainly in response to tougher bank capital regulations.

How The Top 50 Compare: RAC Ratios And Rating Scores

The ICRs and component scores in tables 1 and 2 are based on the main operating company within the group as of Sept. X, 2019. Where applicable, these are not indicative of the ratings on the respective holding companies. Here is a brief explanation of the main column headings in tables 1 and 2:

• Anchor: We derive this by combining our relative economic and industry risk assessments for each national banking sector. For multinational banks, the economic risk is weighted according to the mix of their country exposures.
• Capital and earnings, risk position, combined impact: We produce these rating factors as part of our bank-specific analysis that assesses a particular institution's capital strength and risk profile. The combined notching impact of these two factors, plus the anchor, component scores for business position, and funding and liquidity scores produce the SACP.
• The RAC ratios are point in time. We do not update them for changes in capital measures after the reporting date. However, these ratios are the starting point for our projected RAC ratios, which factor in our forward-looking view about capital and other factors.
• Forecasted RAC ratio range: Our current ratings factor in this component where the time horizon is typically between 18 to 24 months.
• All RAC ratios are based on parameters (for example, the banking industry country risk assessment (BICRA), economic risks (ER), and sovereign ratings) as available at the RAC ratio disclosure reporting date. For example, the 2018 ratios don't capture our actions taken in the course of 2019, such as the Spanish ER change from 5 to 4, or the Polish BICRA and ER change from 5 to 4 and the Portuguese sovereign long-term rating upgrade to BBB' from 'BBB-'.
• Forecasted RAC ratios are calculated using the most recent BICRA scores and sovereign ratings available.

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Related Criteria

• Criteria - Financial Institutions - General: Risk-Adjusted Capital Framework Methodology, July 20, 2017
• Criteria - Financial Institutions - Banks: Banks: Rating Methodology And Assumptions, Nov. 9, 2011

Related Research

• Guidance | Criteria | Financial Institutions | General: Applying The Risk-Adjusted Capital Framework Methodology, Sept. 13, 2018
• The Basel Capital Compromise For Banks: Less Impact Than Meets The Eye, Dec. 8, 2017
• Calibrating The Risk-Adjusted Capital Framework, July 20, 2017
• Credit FAQ: What's Behind S&P Global Ratings' Risk-Adjusted Capital Framework Update, July 20, 2017