Featured Product

    ECB Paper on Macro-Prudential Stress Test of Euro Area Banking System

    July 02, 2019

    ECB published a paper that presents an approach to a macro-prudential stress test for the euro area banking system, comprising the 91 largest euro area credit institutions across 19 countries. The approach involves modeling banks’ reactions to changing economic conditions. It also examines the effects of adverse scenarios on economies and the financial system as a whole by acknowledging a broad set of interactions and interdependencies between banks, other market participants, and the real economy. The results highlight the importance of the starting level of bank capital, bank asset quality, and bank adjustments for the propagation of shocks to the financial sector and real economy.

    The paper presents stress test results in the baseline scenario and lays out the main results for the adverse scenario. All the summarized results are based on banks’ reactions to the original adverse scenario included in the 2018 EU-wide stress testing exercise. Next, the paper elaborates on selected aspects of the adverse and baseline scenarios along with the macro-prudential perspective. It also introduces estimates of the effect of triggering the second-round effects on output and the real economy more broadly. Finally, the paper discusses the potential role of non-banks in the transmission of the adverse scenario. 

    The report evaluates performance of the euro area banking sector in 2018-20 under the scenarios of the 2018 EBA supervisory stress test. The results complement the findings of the supervisory stress test. Compared with the results derived under the constant balance sheet assumption, banks’ system-wide capital depletion in the adverse scenario is higher in the macro-prudential stress test. When comparing adverse system-wide common equity tier 1 (CET1) capital levels in 2020 against the end of 2017, the macro-prudential stress test reveals a EUR 35 billion higher capital depletion then the analogous constant balance sheet exercise for the same sample of banks. However, because of banks’ deleveraging, CET1 ratios are on average higher in the macro-prudential stress test. Compared with the 2018 Financial Sector Assessment Program (FSAP) stress test results, the timing of the impact on bank solvency differs. FSAP foresees a gradual impact of the adverse scenario on banks’ capital, in contrast to the more front-loaded impact in the macro-prudential stress test. The prediction of relatively lower capital ratios by the FSAP is mainly driven by higher severity for certain high-spread economies and by the less pronounced deleveraging of banks facing strained capital levels.

    Banks experiencing a CET1 capital shortfall compared with their capital requirement decrease their lending to a relatively greater degree than do banks with a CET1 surplus. Accordingly, loan growth of a large share of banks in the adverse scenario is negative, especially in the case of non-financial corporations. Interbank contagion may advance the deterioration of banks’ capital shortfalls. A contagion mechanism related to the direct interconnectedness between banks could lead to an additional CET1 ratio depletion amounting to 75 basis points by the end of 2020. This estimate involves both solvency and liquidity distress and assumes a default on bilateral exposures and short-term funding withdrawal by those banks experiencing capital shortfalls. The paper also evaluates the effect of adding the feedback loops between the financial and real sectors, in addition to the interactions between banks and other counterparties in financial and capital markets.

     

    Related Link: ECB Paper (PDF)

     

    Keywords: Europe, EU, Banking, Stress Testing, CET 1, FSAP, Macro-Prudential Policy, Adverse Scenario, Baseline Scenario, EBA, ECB

    Featured Experts
    Related Articles
    News

    APRA Updates Lists of Validation and Derivation Rules in December 2019

    APRA updated the lists of the Direct to APRA (D2A) validation and derivation rules for authorized deposit-taking institutions, insurers, and superannuation entities.

    December 13, 2019 WebPage Regulatory News
    News

    APRA Finalizes Prudential Standard for Credit Risk Management of Banks

    APRA updated the prudential standard on credit risk management requirements (APS 220) for authorized deposit-taking institutions, post a public consultation.

    December 12, 2019 WebPage Regulatory News
    News

    EIOPA Consults on Guidelines on ICT Security and Governance

    EIOPA issued a consultation on guidelines on the Information and Communication Technology (ICT) security and governance by insurers.

    December 12, 2019 WebPage Regulatory News
    News

    BCBS Consults on Design of Prudential Treatment for Crypto-Assets

    BCBS published a discussion paper on the design of prudential treatment for crypto-asset exposures of banks.

    December 12, 2019 WebPage Regulatory News
    News

    NCUA Approves Delay of Risk-Based Capital Rules Until January 2022

    The NCUA Board held its eleventh open meeting of 2019 and approved a final rule to delay the effective date of the risk-based capital rules for credit unions to January 01, 2022.

    December 12, 2019 WebPage Regulatory News
    News

    APRA Issues Operational Risk Rules, Consults on Reporting Requirements

    APRA published an updated prudential standard APS 115 that sets out operational risk requirements for authorized deposit-taking institutions in Australia.

    December 11, 2019 WebPage Regulatory News
    News

    ESMA Updates Q&A on European Benchmarks Regulation in December 2019

    ESMA updated the question and answers (Q&A) document on the European Benchmarks Regulation.

    December 11, 2019 WebPage Regulatory News
    News

    APRA Decides to Keep Countercyclical Capital Buffer for Banks at 0%

    APRA announced its decision to keep the countercyclical capital buffer (CCyB) for authorized deposit-taking institutions on hold at zero percent.

    December 11, 2019 WebPage Regulatory News
    News

    ESMA on Draft Amendments to Indices and Recognized Exchanges Under CRR

    ESMA issued the final report on draft amendments to the Implementing Regulation (EU) 2016/1646, which specifies the main indices and recognized exchanges, under the Capital Requirements Regulation (CRR), that are relevant to credit institutions and investment firms subject to prudential requirements and trading venues.

    December 11, 2019 WebPage Regulatory News
    News

    FED Extends Consultation Period for Capital Requirements for Insurers

    FED is extending comment period for the proposed rule establishing risk-based capital requirements for depository institution holding companies that are significantly engaged in insurance activities.

    December 10, 2019 WebPage Regulatory News
    RESULTS 1 - 10 OF 4316