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The financial and sovereign debt crises have highlighted how important it is for banks to have solid capital buffers that enable them to withstand extreme and unexpected shocks to their balance sheets and thus ensure that they can act as effective financial intermediaries even in periods of turbulence. A macro stress-testing framework is often used to assess in a forward-looking manner the resilience of the banking sector to (adverse) macro-economic and financial developments. In line with its responsibility for safeguarding financial stability in the euro area, the ECB also employs macro stress-testing tools in its regular macro-prudential assessments.
Against this background, this article gives an overview of the main elements of the ECB’s (top-down) macro stress-testing framework for solvency assessments and gives examples of how it is used for policy analysis. The framework is applied in forward-looking bank solvency analysis in many different contexts, such as to analyse the impact of pertinent systemic risks on broad financial stability, to challenge the results of bottom-up stress tests carried out at the supervisory level and to calculate bank capital shortfalls in order to assess the impact of conditions in the financial sector on macro-economic developments. Furthermore, the stress-testing framework can be used for both micro- and macro-prudential purposes once the ECB takes up its supervisory powers in the context of the establishment of the Single Supervisory Mechanism (SSM).
Top-down macro stress-testing has become an important tool for solvency impact assessments. This article has described the current set-up for forward-looking solvency assessments at the ECB and highlighted some of its main uses for policy analysis. Macro stress-testing is an effective tool for gauging in a dynamic manner the resilience and soundness of the banking sector, which is crucial for making informed policy decisions from a micro- and macro-prudential perspective, as well as for monetary policy purposes. Nevertheless, it is important to emphasise that stress test results will always be surrounded by uncertainties and should thus be complemented with other tools and expert judgement in order to achieve a comprehensive assessment of the financial sector.