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Supervisory Stress Testing
Edward O’Brien8 October 2015
Rubric
www.ecb.europa.eu ©
1. A historical perspective:
o ECB stress testing
• Crisis prevention – CEBS/EBA exercises
• Crisis management – country-specific stress tests
2. Comprehensive Assessment
3. Current and future activities:
o EBA 2016 stress test
4. Stress test scenario design
5. Resources
Overview
Rubric
www.ecb.europa.eu ©
ECB stress testing – crisis prevention
o Objectives:
to assess the resilience of the financial system
• Microprudential perspective: “identify trends, potential risks and vulnerabilities stemming from the microprudential level and ensure appropriate action is taken against them” (EBA)
• Macroprudential perspective: gauge the resilience of the financial system to plausible but severe macro-financial stress scenarios and ensure a sufficient level of capital in the banking system
o Challenges:
• Cross-country coordination
• Adverse selection risk
1. A historical perspective
3
Rubric
www.ecb.europa.eu ©
ECB stress testing – crisis prevention
o CEBS/EBA exercises (2009, 2010 & 2011)
o Increasingly stringent
o 2011 impacted market sentiment; sovereign debt crisis
o Followed in 2012 by recapitalisation exercise
o Role of the ECB
o Scenario design
o Methodology
o Benchmark parameters & quality assurance
1. A historical perspective
4
Rubric
www.ecb.europa.eu ©
ECB stress testing – crisis management
o Objectives:
• to gauge the resilience of the financial system and ensure a sufficient level of capital in the system
• But how much is enough?
• Are sufficient backstops available?
• to restore market confidence through increased transparency
o Challenges
1. A historical perspective
5
Rubric
www.ecb.europa.eu ©
ECB stress testing – crisis management
o Country–specific exercises (2010 – 2015)
o Including, for example, Ireland, Spain, Greece, Slovenia, Cyprus
o Role of the ECB
o Scope, design, scenario, governance, quality assurance
o In liaison with EU, IMF, etc.
1. A historical perspective
6
Rubric
www.ecb.europa.eu ©
1. A historical perspective:
o ECB stress testing
• Crisis prevention – CEBS/EBA exercises
• Crisis management – country-specific stress tests
2. Comprehensive Assessment
3. Current and future activities:
o EBA 2016 stress test
4. Stress test scenario design
5. Resources
Overview
Rubric
www.ecb.europa.eu ©
The ECB performed the Comprehensive Assessment prior to assuming full responsibility for supervision
o Mandated by Single Supervisory Mechanism (SSM) Regulation
o The assessment was an important step in preparing for supervision and resulted in:
o greater transparency of banks’ balance sheets
o bank balance sheet strengthening
o improved confidence in the European banking sector
The Comprehensive Assessment was comprised of two main pillars:
o an AQR to enhance the transparency of bank exposures
o by reviewing the quality of banks’ assets, including the adequacy of asset and collateral valuations and related provisions
o a stress test, performed in close cooperation with the EBA
o to examine the resilience of banks’ balance sheets to adverse circumstances
2. Comprehensive Assessment 2014
8
Rubric
www.ecb.europa.eu ©
Important features distinguish the CA from previous EU-wide exercises:
o the combination of AQR and stress test
o a systematic and centrally-led quality assurance process
Transparent processes to achieve transparent outcomes
o three significant publications outline the complete methodology and process of the ECB’s Comprehensive Assessment
• AQR Phase 2 Manual
full details of the AQR’s 10 components
• EBA Stress Test Methodology
bottom-up stress test methodology
• CAST Manual
quality assurance process
join-up methodology
2. Comprehensive Assessment 2014, cont.
9
Rubric
www.ecb.europa.eu ©
• Common methodology, templates • Data hub for final dissemination
• Common scenario (in cooperation with ECB, NCAs)
• Responsible for the quality assurance• Assessment of the reliability and
robustness of banks’ assumptions, data, estimates and results
• Supervisory reaction function
123 banks in 2014 EU-wide stress test
ECB, National Supervisory Authorities
European Systemic Risk BoardEuropean Commission
European Banking Authority
Non-SSMNational
Competent Authorities
SSMECB, National
Competent Authorities
20 non-euro area EU banks 103 SSM banks
Joint work and inform
ation sharing
2. Comprehensive Assessment 2014, cont.
130 banks in 2014 ECB CA
103 SSM banks 27 non-EBA banks
10
Rubric
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o Quality Assurance was vital to ensure• robust results of the Comprehensive Assessment
• a level playing field for banks covered by the exercise
o Multiple layers of Quality Assurance• Banks, NCAs, third parties and ECB
o A central Quality Assurance framework was put in place• to reviews results from:
• individual country perspectives
• cross-market perspectives
• and by risk dimension
2. Comprehensive Assessment 2014, cont.
11
Rubric
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o The central Quality Assurance framework • employed ECB top-down stress test models
• was highly automated and data driven
• efficient, to maximise impact and coverage
• facilitated active dialogue with NCAs
• prioritised areas of concern, targeting the most material findings
• harnessed complementary qualitative information on each bank
2. Comprehensive Assessment 2014, cont.
12
Rubric
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• The Asset Quality Review (AQR) resulted in a gross impact on asset carrying values of €48 billion
• In total, a €136 billion increase in non-performing exposure was identified
• Combining the AQR with the stress test the Comprehensive Assessment resulted in:- €263 billion capital depletion over the three-year horizon of the exercise under the adverse stress test scenario- Median 4% reduction of the CET1 capital ratio
• In aggregate, the Comprehensive Assessment resulted in a €24.6 billion capital shortfall across 25 participating banks
2. Comprehensive Assessment 2014, cont.
13
Rubric
www.ecb.europa.eu ©
1. A historical perspective:
o ECB stress testing
• Crisis prevention – CEBS/EBA exercises
• Crisis management – country-specific stress tests
2. Comprehensive Assessment
3. Current and future activities:o EBA 2016 stress test
4. Stress test scenario design
5. Resources
Overview
Rubric
www.ecb.europa.eu ©
o Country-specific stress tests – Greece 2015
o Macroprudential stress testing?
o EBA EU-wide 2016 exercise
o Evolution of 2014 methodology
o Constrained bottom-up; static balance sheet
o Q1 – Q3 2016
o Role of the ECB
o First exercise under SSM regime
o Role in bottom-up and top-down testing
o Scenario design
o Quality assurance
3. Current and future activities
15
Rubric
www.ecb.europa.eu ©
1. A historical perspective:
o ECB stress testing
• Crisis prevention – CEBS/EBA exercises
• Crisis management – country-specific stress tests
2. Comprehensive Assessment
3. Current and future activities:
o EBA 2016 stress test
4. Stress test scenario design
5. Resources
Overview
Rubric
www.ecb.europa.eu ©
o The baseline scenario is prepared by the European Commission
o The adverse scenario is proposed by the European Systemic Risk Board (ESRB)
• working in close collaboration with the ECB and the EBA
• approved by the EBA Board of Supervisors
o Adverse scenario captures the prevailing view of systemic risks facing the EU financial system
• as identified by the ESRB General Board
• on the basis of analytical support from the ECB
o It includes forward-looking paths for key macroeconomic and financial variables for all EU countries and a large number of non-EU countries over a three-year horizon
4. Stress test scenario design
17
Rubric
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Key risks to euro area financial stability
4. Stress test scenario design, cont.
Taken from November 2013 ECB Financial Stability Review
18
Rubric
www.ecb.europa.eu ©
o Starting point: global sources of risk
• Increased risk aversion, broad-based sell-offs and re-pricing
• EMEs specifically impacted, with a severe decline in world trade
• Currency depreciation and funding stress in CEEs
o Triggering EU-specific risks
• Domestic demand confidence-driven shocks (real estate too)
• Sovereign bond yield differentiation re-appearing
• Access to and costs of bank funding impacted
4. Stress test scenario design, cont.
19
Rubric
www.ecb.europa.eu ©
o The baseline scenario is prepared by the European Commission
o The adverse scenario is proposed by the European Systemic Risk Board (ESRB)
• working in close collaboration with the ECB and the EBA
• approved by the EBA Board of Supervisors
o Adverse scenario captures the prevailing view of systemic risks facing the EU financial system
• as identified by the ESRB General Board
• on the basis of analytical support from the ECB
o It includes forward-looking paths for key macroeconomic and financial variables for all EU countries and a large number of non-EU countries over a three-year horizon
4. Stress test scenario design
20
Rubric
www.ecb.europa.eu ©
Cumulative GDP impacts in previous CEBS/EBA stress test exercises (Deviation of adverse from baseline growth rates in percentage points)
2014 comparison with past EU-wide stress tests
4. Stress test scenario design – scenario comparisons
21
Rubric
www.ecb.europa.eu ©
1. A historical perspective:
o ECB stress testing
• Crisis prevention – CEBS/EBA exercises
• Crisis management – country-specific stress tests
2. Comprehensive Assessment
3. Current and future activities:
o EBA 2016 stress test
4. Stress test scenario design
5. Resources
Overview
Rubric
www.ecb.europa.eu ©
o European Central Bank
• “A macro stress testing framework for assessing systemic risks in the banking sector”
(http://www.ecb.europa.eu/pub/pdf/scpops/ecbocp152.pdf)
• Comprehensive Assessment
(https://www.bankingsupervision.europa.eu/banking/comprehensive/html/index.en.html)
o European Banking Authority
• EU-wide stress testing 2016
(http://www.eba.europa.eu/risk-analysis-and-data/eu-wide-stress-testing/2016)
5. Resources
23
