EBA launches 2016 EU wide stress test exercise
24 February 2016
The European Banking Authority released the methodology and macroeconomic scenarios for the 2016 EU-wide stress test.
The stress test is designed to provide supervisors, banks and other market participants with a common analytical framework to consistently compare and assess the resilience of EU banks to economic shocks. For this exercise, no single capital thresholds have been defined as the results will inform the 2016 round of Supervisory Review and Evaluation Processes (SREP) under which decisions are made on appropriate capital resources. The EBA expects to publish the results of the exercise in early Q3 2016.
Key features of the methodology and the scenario
The common methodology assesses solvency and covers all main risk types including: credit risk and securitisation, market risk, sovereign risk, funding risk and operational and conduct risks. The 2016 EU-wide stress test is run on banks' models and the results are then challenged by supervisors in the relevant competent authorities (CAs). To ensure consistency, the methodology contains key constraints such as a static balance sheet assumption, which precludes any mitigating actions by banks, and a series of caps and floors, for example on risk weighted assets (RWAs) and net trading income. In 2016, no pass fail threshold has been included as the objective is to use the stress test as a supervisory tool, whose results will be discussed with individual banks in the SREP process, where mitigating actions may also be considered.
The adverse scenario, designed by the European Systemic Risk Board (ESRB), reflects the four systemic risks that are currently assessed as representing the most material threats to the stability of the EU banking sector: i) an abrupt reversal of compressed global risk premia, amplified by low secondary market liquidity; ii) weak profitability prospects for banks and insurers in a low nominal growth environment, amid incomplete balance sheet adjustments; iii) rising of debt sustainability concerns in the public and non-financial private sectors, amid low nominal growth; iv) prospective stress in a rapidly growing shadow banking sector, amplified by spillover and liquidity risk.