Banks are facing an ‘extreme but plausible’ scenario
The 2021 edition of the stress tests, the results of which are expected in July, is held under peculiar circumstances, but these do not fundamentally affect the exercise.
Banks are currently undergoing EU-wide stress testing, an exercise closely scrutinised by regulators. The Director of the stress testing function has outlined the main features of the exercise.
The European Banking Authority (EBA) celebrates its 10th anniversary this year. The institution was founded in the wake of the 2008 financial crisis as part of the European System of Financial Supervision, and is now responsible for conducting banking stress tests. Whereas the 2020 exercise was cancelled due to the pandemic, the 2021 edition was launched at the end of January and will cover about fifty institutions across the continent, accounting for no less than 70% of its banking assets. Two wholly Belgian institutions are to undergo stress testing: KBC and Belfius. The assets of BNP Paribas Fortis and ING Belgium are recognised in the balance sheets of their respective parent companies.
This perilous exercise has been orchestrated by Italian-born Mario Quagliariello for the past three years: ‘Stress testing is a tool that allows the supervisory authority to assess how banks would react in an adverse scenario, which would be an extreme but plausible situation. The assumed scenario is extreme because it must be a shock for the bank, so that we can assess its degree of resilience, and it must be plausible so that it can serve as a guide for decision-makers.’
To carry out its mission, the EBA has eight full-time equivalent posts. ‘You can imagine that this is not a large number given the magnitude of the exercise, but our team is very efficient and of excellent quality’, notes the Director. ‘However, we also receive support from the competent authorities. We have a few experts in our team, especially in the field of statistics to gather data, and in the field of benchmarking to assess which banks are too optimistic in relation to others.’
‘If the recovery is held back by the emergence of a third wave, we will use these stress tests as input for decision-making on other measures.’
Director Of Economic Analysis and Statistics at the EBA
The EBA oversees the stress tests, but their implementation follows a ‘bottom-up’ approach: the banks receive the methodology, a scenario and models to be applied. It is then up to the banks to determine the impact a shock may have on their balance sheet. ‘If a bank is overly optimistic for any given reason, a methodological backstop is in place to mitigate risks’, says Mario Quagliariello. One reason why the stress tests are comparative is to detect anomalies, so that national regulators are able to see how similarly sized institutions would respond in different countries.
Impact of Covid
The 2021 edition of the stress tests, the results of which are expected in July, is held under peculiar circumstances, but these do not fundamentally affect the exercise. The resulting data will be interpreted in accordance with the summer context. ‘If the crisis comes to an end, we will look at strategies to exit the exceptional support measures provided by the authorities. If the recovery is held back by the emergence of a third wave, we will use these stress tests as input for decision-making on other measures’, says Mario Quagliariello. The context of long-term low interest rates is also embedded in the scenarios.
Although national averages are not always relevant, the latest results show that the Belgian banking sector, which was hit hard in 2007-2008, is managing rather well. As a result, the capital levels and asset quality of Belgian banks are slightly better than in other countries, but their profitability remains rather low, which remains a European problem.
The interview was conducted by Olivier Samois.
L'Echo, 3 March 2021.