Featured Product

    Donald Kohn of BoE Remarks on UK Experience with CCyB and Stress Tests

    September 04, 2019

    While speaking at a conference in London, Donald Kohn of BoE discussed the UK experience with stress tests and outlined the ways in which stress tests in the UK differ from those in the U.S. He took a deep dive into the causes and consequences of procyclical risk-based bank capital and the role the Financial Policy Committee (FPC) envisions for the CCyB, informed by stress tests, in countering this tendency. Finally, he offered an overview of the modeling challenges and the remaining information gaps in this area, also revealing that BoE is expected to release an updated approach to stress testing document later this year.

    Mr. Kohn revealed that, in 2019, BoE is undertaking a qualitative review of the effectiveness of the stress testing models of banks; the Prudential Regulation Committee (PRC) is expected to include the reference to qualitative review outcomes in this year’s publication of bank-specific assessments. He explained that FPC has adopted the CCyB, using the stress tests as a key input to the decisions on the level of risks and required capital. The stress tests have been an important element in enabling the FPC to move the CCyB up and down as the risk environment has evolved, but they also have proved invaluable in several other dimensions. FPC uses the stress test results together with indicators and judgment to assess the level of risk and of the banking system’s resilience to that risk. To assess the risk environment and the likely resilience of the banks to risk events, FPC considers a wide range of economic and financial indicators as well as supervisory and market intelligence. Stress tests serve as a check on the FPC judgment and help it to detect changes in the structure and composition of bank balance sheets that affect their resilience to unexpected developments. However, there is no mechanical link between the outputs of the stress test or the readings from a set of indicators and the setting of CCyB.

    For CCyB to be able to counter the inherent procyclicality of bank risk-based capital calculations, the stress test inputs to the FPC decisions should generate estimates of rising losses as risks increase. However, he highlighted that challenges and gaps remain in research related to the modeling of the dynamic evolution of financial networks and focus on the interaction of contagion channels. In addition, key challenges remain for further development and research on further integrating solvency and liquidity stress into a single modeling framework. Areas of gaps include extending models to the wider global banking system; considering feedback channels between banks and the real economy; considering links to the wider financial system and the impact of banks’ actions on other institutions; and researching the implications that information contagion plays in financial stability. Beyond banking sector stress tests, a major challenge is the development of a general equilibrium macro-financial framework that can mimic the way that the wider financial system and real economy endogenously generate crises. Such models could be used to find weak points in the financial system, where adding resilience could bring significant benefits for the system as a whole.

    Overall, the stress tests are an important cross-check on FPC and PRC judgment and should be helpful to overcome any inaction bias that might creep into capital determination at some later date. However, Mr. Kohn warned that the CCyB and the stress tests have not been tested in an economic downturn. He concluded: "We need to be sure that capital builds up sufficiently with risks so that when the CCyB is released those who are funding banks have the confidence to support banks’ efforts to continue lending to households and businesses even as the economy falls into recession. We need to make sure we do release the CCyB promptly, even proactively as in 2016, to allow banks the scope to make those loans even as loses begin to rise-and we need to assure that the stress test scenarios and results are fully supportive of an appropriate release."

     

    Related Link: Speech

     

    Keywords: Europe, UK, Banking, Stress Testing, CCyB, Macro-Prudential Policy, Procyclicality, Contagion Risk, BoE

    Featured Experts
    Related Articles
    News

    EC to Defer Application of SFDR Standards Till July 2022

    The European Commission (EC) announced plans to defer the application of 13 regulatory technical standards under the Sustainable Finance Disclosure Regulation (2019/2088) by six months, from January 01, 2022 to July 01, 2022.

    July 23, 2021 WebPage Regulatory News
    News

    BoE Consults on Approach to Setting MREL, Publishes Bail-In Guidance

    The Bank of England (BoE) published a consultation paper on approach to setting minimum requirement for own funds and eligible liabilities (MREL), an operational guide on executing bail-in, and a statement from the Deputy Governor Dave Ramsden.

    July 22, 2021 WebPage Regulatory News
    News

    EBA Seeks Views on Proportionality Assessment Methodology

    The European Banking Authority (EBA) is seeking preliminary input on standardization of the proportionality assessment methodology for credit institutions and investment firms.

    July 22, 2021 WebPage Regulatory News
    News

    US Agencies Propose Changes to Call Reports and Instructions

    Certain regulatory authorities in the US are extending period for completion of the review of certain residential mortgage provisions and for publication of notice disclosing the determination of this review until December 20, 2021.

    July 22, 2021 WebPage Regulatory News
    News

    PRA Finalizes Rulebook Definition of Higher Paid Material Risk-Taker

    The Prudential Regulation Authority (PRA) published the policy statement PS18/21, which introduces an amendment in the definition of "higher paid material risk taker" in the Remuneration Part of the PRA Rulebook.

    July 21, 2021 WebPage Regulatory News
    News

    EBA Examines Asset Encumbrance in Banking Sector

    The European Banking Authority (EBA) published its annual report on asset encumbrance in banking sector.

    July 21, 2021 WebPage Regulatory News
    News

    EBA Publishes Methodological Guide to Mystery Shopping

    The European Banking Authority (EBA) published a methodological guide to mystery shopping.

    July 21, 2021 WebPage Regulatory News
    News

    APRA Issues Update on Capital Reform Policy Settings for Banks

    The Australian Prudential Regulation Authority (APRA) released a letter to authorized deposit-taking institutions to provide an update on key policy settings for the capital framework reforms, which will come into effect from January 01, 2023.

    July 21, 2021 WebPage Regulatory News
    News

    CPMI-IOSCO Assess Continuity Planning of Market Infrastructures

    The Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO) published a report that assesses the business continuity planning activities of financial market infrastructures or FMIs.

    July 21, 2021 WebPage Regulatory News
    News

    ESMA Responds to Proposal Related to Sustainability Standards Board

    The European Securities and Markets Authority (ESMA) has responded to the IFRS consultation on targeted amendments to the IFRS Foundation constitution to accommodate an International Sustainability Standards Board (ISSB) to set IFRS Sustainability Standards.

    July 21, 2021 WebPage Regulatory News
    RESULTS 1 - 10 OF 7283