Model scrutiny depletes Santander’s capital ratio

Targeted review of internal models takes 28bp off CET1 ratio year-to-date

To make amends for deficient risk models, Spanish lender Santander had to absorb a capital add-on in Q3, its third in as many quarters. 

The bank took a 13-basis point hit to its Common Equity Tier 1 (CET1) capital ratio over the three months to end-September as part of the targeted review of internal models (Trim) conducted by the European Central Bank. This was close to double the 8bp penalty incurred in Q2. In Q1, the sanction was 7bp.

 

Over the first nine months of the year, regulatory adjustments, including Trim effects and accounting changes, drained Santander’s CET1 ratio by 53bp. These have more than offset the 48bp increase due to earnings.

The firm’s Q3 CET1 ratio was 11.3%, flat on Q2 and up from 11.1% the same quarter a year ago.

Who said what

“Overall, between 2019 and 2020 … we expect not 100 basis points, but probably in the region of maybe 80, 90 basis points [of] overall regulatory impact, of which probably 60 or more comes this year” – José Antonio Alvarez, chief executive officer at Santander.

What is it?

The targeted review of internal models was launched by the European Central Bank in 2016 to assess whether the models used by banks to calculate their statutory capital requirements are fit for purpose and align with all applicable regulations. 

The review is being conducted in two phases. The first stage review focused on credit risk models for small and medium-sized enterprise and retail portfolios, counterparty credit risk and market risk models. 

By the end of the review, ECB supervisors will have completed around 200 on-site investigations at 65 banks. So far, about three-quarters of the missions have been completed. 

Why it matters

Regulatory headwinds have frustrated Santander’s efforts to improve its CET1 capital ratio, which lags the European Union average of 14.6%.

Though it is currently above mandatory minimums, the concern is that a series of lacklustre earnings could erode it further, limiting the amount of capital available to distribute to shareholders.

By the chief executive officer’s own admission, another 30–40bp deduction due to regulatory adjustments is expected by end-2020. If earnings growth cannot make up for this, there’s only one way Santander’s ratio will be going: down. 

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