ESRB published an occasional paper that shows results from the ESRB surveys of the responses of banks and insurance companies to stress tests. The paper describes the surveys and their insights regarding potential adverse feedback loops. The paper does not necessarily characterize current systemic risks, but rather elucidates the value of macro-prudential surveys and discusses the methodological issues that arise in their implementation.
The existing stress tests do not capture feedback loops between individual institutions and the financial system. To identify feedback loops, ESRB has developed macro-prudential surveys that ask banks and insurers how they would behave in a macroeconomic stress scenario. In a pilot application of these surveys, the evidence of herding behavior in the banking sector was noted, particularly concerning credit retrenchment. Results showed that the consequences can be large, potentially undoing the initial effects of banks’ remedial actions by worsening their solvency position. In contrast, insurers’ responses to the survey provided little evidence of herding in response to macroeconomic stress.
These results highlighted the usefulness of macro-prudential surveys in identifying feedback loops. By analyzing survey responses, macro-prudential policymakers can identify systemic risks arising from herding behavior during periods of financial stress. The surveys, therefore, provide a macro-prudential overlay to the large-scale micro-prudential stress tests that have become a cornerstone of the post-crisis financial supervision.
Related Link: Occasional Paper (PDF)
Keywords: Europe, EU, Banking, Insurance, Stress Testing, Financial Stability, Macro-prudential Survey, Systemic Risk, ESRB
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