Featured Product

    ECB Vice President Discusses Evolution of Stress Testing in Europe

    September 04, 2019

    At the annual US-EU Symposium in Frankfurt, the ECB Vice President Luis de Guindos discussed the evolution of stress testing in Europe, also highlighting the ongoing discussions on long-term strategy for the use of micro- and macro-prudential stress tests. He focused on two key facets of this evolution: the more integral use of the top-down review process and the advantages of adding a macro-prudential perspective to stress testing. He also emphasized that it may be worth regularly publishing the results of the top-down, macro-prudential stress tests, possibly alongside the results of the micro-prudential exercise. This simultaneous publication would provide stakeholders with a more solid and comprehensive overview of the resilience of the banking sector.

    The ECB Vice President highlighted that, in Europe, the stress tests offer important inputs for the Supervisory Review and Evaluation Process (SREP) of ECB. Rather than finishing with a pass or fail assessment, stress tests provide a starting point, both for discussions between banks and supervisors and for macro-prudential policymakers. The EU-wide stress tests involve significant input from the banks, following a constrained bottom-up approach. In addition to describing the constrained bottom-up approach, he explained certain drawbacks of this approach. For instance, the static balance sheet assumption limits the realism of the exercise as it does not account for how banks would respond under stressful situations. Certain caps and floors in the stress test methodology may compromise the realism of the stress test outcome. The approach also provides banks with substantial leeway to materially underestimate their vulnerability to adverse circumstances—to "game" the exercise, in other words. Consequently, the European supervisors conduct a thorough quality assurance of banks' bottom-up stress test results to ensure that their outcomes are credible. This includes confronting banks with independent model-based estimates—"a so-called top-down model challenge." This process generally leads to individual banks revising their stress test outcomes before publication.

    Mr. Guindos believes that there is substantial value in this extensive supervisory scrutiny and in the improved market discipline stemming from the European stress test framework. He added that discussions about the long-term strategy for the stress tests in Europe are underway, at both the ECB/Single Supervisory Mechanism and the EBA levels. Proposed changes aim to improve the realism of stress test outcomes while retaining their reliability and credibility. He then focused on one key aspect of the proposed changes, namely the importance of top-down models, in the context of the European prudential stress tests. The top-down model challenge, which has so far taken the form of a dialog between supervisors and banks, could play a greater role in disciplining banks and reducing the incentives for them to systematically underestimate their vulnerabilities, said the ECB Vice President. This could be achieved by publishing the top-down view of supervisory stress tests, which will provide market participants with a benchmark against which to judge the results of each bank. The results could be published in individually, in aggregate form, or in ranges such as grouping banks into solvency categories that could be compared with bottom-up, bank-by-bank results. There is also a range of model-based results that could be produced and published.

    Next, he discussed the advantages of taking a macro-prudential perspective with stress testing and described the key elements that characterize macro-prudential stress testing. Developing the models and infrastructure for these tests enables supervisors and regulators to analyze a range of scenarios, helping them to better understand the links between banks, other parts of the financial sector, and the wider economy. This also means that they are able to see how the banking sector reacts to a number of alternative macro-prudential policy paths, helping them to ensure that the macro-prudential measures in place remain appropriate and adequate. Additionally, there are benefits from conducting both micro-prudential and macro-prudential exercises simultaneously. A combined exercise would help banks, market participants, and regulators to assess the system-wide consequences of reactions of banks to situations of stress, which would complement the information retrieved from the micro-prudential stress tests.

     

    Related Link: Speech

     

    Keywords: Europe, EU, Banking, Stress Testing, Macro-Prudential Policy, Micro-Prudential Stress Test, Top-Down Stress Test, Bottom-Up Stress Test, SSM, SREP, ECB, BIS

    Featured Experts
    Related Articles
    News

    BOE Article Explains Process for Bank Authorization in UK

    BoE published an article, in the Quarterly Bulletin for the third quarter of 2019, on how banks are authorized in the UK.

    September 20, 2019 WebPage Regulatory News
    News

    HKMA on Commencement of Regulatory Regime Under Insurance Ordinance

    HKMA announced the commencement of new licensing and regulatory regime for insurance intermediaries under the Insurance Ordinance from September 23, 2019.

    September 20, 2019 WebPage Regulatory News
    News

    APRA Revises Standard on Margin Rules for Uncleared Derivatives

    APRA revised CPS 226, which is the prudential standard on margin and risk mitigation requirements for non-centrally cleared derivatives.

    September 19, 2019 WebPage Regulatory News
    News

    SEC Adopts Rules and Amendments Under Regulatory Regime for Swaps

    SEC announced that it took a significant step toward establishing the regulatory regime for security-based swap dealers (SBSDs) by adopting a package of rules and rule amendments under Title VII of the Dodd-Frank Act.

    September 19, 2019 WebPage Regulatory News
    News

    FCA Welcomes ISDA Protocol on Narrowly Tailored Credit Events

    FCA published an update to its initial joint statement with the U.S. SEC and CFTC on opportunistic strategies in the credit derivatives markets.

    September 19, 2019 WebPage Regulatory News
    News

    PRA Issues Consultation on Prudent Person Principle Under Solvency II

    PRA, via the consultation paper CP22/19, has set out its proposed expectations for investment by firms, in accordance with the Prudent Person Principle (PPP).

    September 18, 2019 WebPage Regulatory News
    News

    PRA Proposal on Probability of Default and LGD Estimation

    PRA proposed, via the consultation paper CP21/19, an approach to implementing EBA’s recent regulatory products relating to Probability of Default (PD) estimation, Loss Given Default (LGD) estimation, and the treatment of defaulted exposures in the internal ratings-based (IRB) approach to credit risk.

    September 18, 2019 WebPage Regulatory News
    News

    BIS Formalizes Agreement to Set Up Innovation Hub in Hong Kong SAR

    BIS and HKMA signed the Operational Agreement on the BIS Innovation Hub Center in Hong Kong Special Administrative Region (SAR).

    September 18, 2019 WebPage Regulatory News
    News

    APRA Observations from Thematic Review on Recovery Plans of Insurers

    APRA issued a letter to general insurers and life insurers, outlining observations from a recent thematic review on recovery planning by insurers.

    September 18, 2019 WebPage Regulatory News
    News

    BNM Publishes Financial Stability Review for the First Half of 2019

    BNM published Financial Stability Review for the first half of 2019.

    September 18, 2019 WebPage Regulatory News
    RESULTS 1 - 10 OF 3853