The Financial Stability Institute (FSI) of BIS published a brief note that examines the adjustments to stress tests in response to the COVID-19 pandemic. The note discusses how three authorities in UK, EU, and US (BoE, ECB, and FED, respectively) have adjusted the regular stress testing exercises to provide an initial assessment of the impact of the pandemic on the banking sector. The brief concludes with reflections about the relevance of stress tests during the pandemic and the possible expansion of the use of stress testing from a first-response tool to a more a precise instrument that can be applied to individual banks.
In response to the COVID-19 pandemic, three authorities (BoE, ECB, and FED) that regularly conduct stress tests on individual banks adjusted their approach. They performed ad hoc exercises to assess the vulnerability of banking sectors in their jurisdictions. The ad hoc exercises were conducted mid-year, following a rapid deterioration in economic conditions that had emerged by the end of the first quarter of 2020. These exercises were different from the regular stress tests in terms of key features such as objectives, design, methodologies, and communication. However, some of the features of the regular stress tests did not change. The brief includes a table that summarizes the approach taken by the authorities that decided to conduct a first round of these ad hoc exercises. In all cases, the exercises comprised only the top-down component and banks were not involved. Also, the COVID-19-related policy response was incorporated into the three ad hoc stress tests in different ways.
The analysis concluded that stress tests, being forward-looking assessments of bank resilience, represent a useful instrument in the toolkit of authorities to assess condition of banks even under unusual circumstances such as the ones created by the COVID-19 pandemic. The experience of the three exercises discussed in the brief showed, however, the difficulties of adjusting a complex exercise such as an annual stress test to a very different set of conditions. In response to the COVID-19 pandemic, stress tests can, in the first instance, help gauge the system-wide impact of the pandemic on the banking sector. This can help authorities in comparing the economic impact of the pandemic against the capacity of the banking sector to continue supporting the real economy by providing credit to it. However, over time, it may be important to have a more granular view of the impact of pandemic on individual banks. This in turn will help guide any possible supervisory or resolution action. For this to happen, the initial adjustments in the stress testing frameworks that were introduced in first response to the pandemic would benefit from further refinement. Importantly, stress tests under COVID-19 can be most effective when authorities explain the objectives of these exercises and ensure that they are well-aligned with the way the results will be employed and shared with the banks and the public.
Keywords: International, Americas, Europe, EU, UK, Banking, COVID-19, Stress testing, Basel, BoE, ECB, FSI, BIS
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