CEBS publishes consultation paper on stress testing

The Committee of European Banking Supervisors (CEBS) today starts a public consultation on additional technical guidance on the application of the supervisory review process under the Capital Requirements Directive (CRD). The consultation paper on stress testing (CP12) complements CEBS guidelines on the supervisory review process issued in January 2006 and reflects a common understanding among European supervisory authorities on stress testing.

As part of CEBS? guidelines on the application of the supervisory review process (SRP), the guidelines on stress testing will be applied within the dialogue between supervisors and institutions and should not be interpreted as resulting automatically in the need for additional capital.

The term stress testing is used in the proposed guidelines to describe the various techniques used by institutions to gauge their vulnerability to exceptional but plausible events. CEBS considers it important for institutions to embed stress testing into their risk management framework.

Stress testing is recognised as being an internal process within institutions. As such institutions should, in the context of their internal capital adequacy assessment process (ICAAP), also assess how their earnings would be affected by stress situations.

The concept of proportionality also applies to stress testing, meaning that the complexity of stress testing will be expected to be related to the size of institutions as well as to the sophistication and diversification of their activities. In this context, the paper emphasizes that there is no single ?correct? stress testing methodology or procedure. What is adequate for an individual institution depends very much on proportionality and the development of its practices over time. Thus, an important part of the supervisors? assessment of stress testing will be based on a continuing dialogue with institutions.

The proposed guidelines are drafted as guidance to supervisors. However, since the guidelines express CEBS? expectations of how national supervisory authorities should deal with the stress testing of their institutions, they clearly also affect the institutions that use these approaches. The guidelines will be updated according to evolving market practices, as and when necessary.