The European Central Bank has published a working paper developing two quarterly indicators that convert information from biennial European Union solvency stress tests into more frequent measures of euro area banking vulnerabilities. The Stress Vulnerability Index estimates potential Common Equity Tier 1 capital depletion under adverse scenarios, while the Profitability Vulnerability Index measures pressure on banks’ ability to generate capital through earnings. Together, they distinguish prospective solvency risks from current loss absorption capacity and can inform decisions on building, preserving or releasing prudential buffers. The Stress Vulnerability Index draws on the 2018, 2021 and 2023 EU-wide stress tests and places particular weight on macroeconomic drivers of credit losses, including unemployment, economic growth and real estate prices. The Profitability Vulnerability Index uses bank and macrofinancial data from the first quarter of 2001 through the fourth quarter of 2024, with interest rates and financial market conditions playing a larger role. Both indices captured the Global Financial Crisis and European Sovereign Debt Crisis, but their divergence during the 2022-2023 monetary tightening cycle showed stronger profitability alongside increased tail risks to capital. The authors find that the latest readings continue to show slightly elevated stress vulnerability despite improved profitability. They argue that this supports preserving existing buffers rather than reducing them while tail risks and uncertainty remain elevated. Both indices were also strongly associated with the probability that euro area banks received state aid after the Global Financial Crisis, including country-wide guarantees and recapitalization schemes.
European Central Bank working paper proposes two quarterly indices to track bank capital and earnings vulnerabilities
A European Central Bank working paper proposes two quarterly indices measuring potential bank capital depletion and pressure on earnings capacity. The indicators can separate prospective solvency risks from current profitability weakness and support prudential buffer decisions. Recent divergence points to improved earnings but still-elevated tail risks, supporting the preservation of existing buffers.