The International Monetary Fund’s recent assessment found that Luxembourg’s financial system can sustain severe shocks, though some banks show vulnerability. Photo: Shutterstock

The International Monetary Fund’s recent assessment found that Luxembourg’s financial system can sustain severe shocks, though some banks show vulnerability. Photo: Shutterstock

In the event of macrofinancial adverse scenario, four banks in Luxembourg would see their common equity tier 1 capital ratio drop below 8%, and five banks would experience a decline below 3% in their leverage ratio--with two of these banks falling below both thresholds--according to a recent IMF report.

The International Monetary Fund has notified the Luxembourg authorities of five ‘potentially weak’ banks in a released on Friday 7 June 2024. This evaluation, part of the financial sector assessment program conducted between October 2023 and January 2024, aimed to identify systemic risks in the financial sector and develop policies to bolster its resilience against shocks and contagion.

The stress tests revealed that the banking sector overall displayed significant resilience. These tests employed a common equity tier 1 capital ratio threshold of 8% on average and a leverage ratio of 3% as a secondary threshold. Results indicated that the banking system, with robust capitalisation and liquidity buffers, could withstand severe scenarios, including stagflation and high retail deposit runs, demonstrating overall resilience across the financial sector.

In the baseline scenario, the aggregate banking system from a sample of 39 banks demonstrated resilience to the recent increase in interest rates, with only three banks accounting for 8.5% of assets considered weak. These banks are projected to see their leverage ratio fall below the 3% threshold in 2024. Additionally, one bank is expected to witness its CET1 ratio decline below 8% by 2025/2026, attributed to its low initial capitalisation and profitability, according to the IMF. However, in a macrofinancial adverse scenario, five banks would experience a decline below the 3% threshold, identified as ‘potentially weak’ by the IMF, although individual bank names were not disclosed. The anticipated recapitalisation needs, ranging from 0.5% to 1% of GDP, were deemed manageable.

Additionally, the projected CET1 ratio of the banking sector is expected to decrease by 4.1 percentage points, from 21.7% in December 2023 to 17.6% in 2024, with private banks facing the most significant capital depletion from non-interest income losses, while corporate finance banks are expected to have the lowest average level of capitalisation.

As part of its macroprudential policy recommendations, the IMF urged Luxembourg to enhance the resilience of its banks against stock vulnerabilities by increasing capital buffer requirements. Additionally, the IMF suggested improving bank liquidity stress tests by incorporating cash-flow data for key currencies.

Commenting on the report, the Luxembourg Financial Sector Supervisory Commission (CSSF) told Delano on Wednesday that, “The methodology, scenario, and overall results of the IMF Stress Test for Luxembourgish banks are aligned with those of the annual and biannual Stress Testing exercises conducted at the CSSF and the European Central Bank. The results serve as an input for the respective competent authorities to assess whether--and if so, which--additional prudential measures need to be applied for the banks under stress.”

The CSSF spokesperson acknowledged that the IMF recommendation to further fortify Luxembourg banks’ resilience by increasing a capital requirement is being “discussed at the CSSF.”

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