EBA issues 2018 EU-wide stress test methodology for discussion

The European Banking Authority (EBA) published today its 2018 EU-wide stress test draft methodology and templates for discussion with the industry. The exercise will cover 70% of the EU banking sector and will assess EU banks' ability to meet relevant supervisory capital ratios during an adverse economic shock.  The methodology covers all relevant risk areas and, for the first time, will incorporate IFRS 9 accounting standards. The results will inform the 2018 Supervisory Review and Evaluation Process (SREP), challenging banks' capital plans and leading to relevant supervisory outcomes.  The exercise will also provide enhanced transparency so that market participants can compare and assess the resilience of EU banks on a consistent basis. The list of institutions participating in the exercise is also released today.

 

The 2018 EU-wide stress test will be carried out at the highest level of consolidation on a sample of 49 EU banks, 35 of which falling under the jurisdiction of the Single Supervisory Mechanism (SSM). No single capital threshold is defined for this exercise as banks will be assessed against relevant supervisory capital ratios under a static balance sheet and the results will be an input to the SREP, under which decisions are made on appropriate capital resources and forward looking capital plans.

 

For banks starting to report under IFRS 9 in 2018, the 2018 EU-wide stress test takes into account the impact of the implementation of IFRS 9 on 1 January 2018 both in terms of starting point and projections.

 

The final methodology will be published as the exercise is launched, at the beginning of 2018, and the results to be published in mid-year 2018.

Objective and approach

The objective of the EU-wide stress test is to provide supervisors, banks and other market participants with a common analytical framework to consistently compare and assess the resilience of EU banks and the EU banking system to shocks, and to challenge the capital position of EU banks. The exercise is based on a common methodology and a set of templates that capture starting point data and stress test results. The resilience of EU banks will be assessed against a macroeconomic baseline and adverse scenario based on year-end 2017 figures, and applied over a period of three years. The approach of the exercise is again that of constrained bottom-up stress test, where banks will be required to project the impact of the scenarios on their projected P&L and capital position but subject to strict constraints defined in the common methodology – for instance simplifying assumptions on the projection of credit risk losses under IFRS 9 and setting a cap on projected net interest income.

 

Methodology and templates

Similar to the 2016 exercise, the 2018 EU-wide stress test is primarily focused on the assessment of the impact of risk drivers on the solvency of banks. Banks are required to stress test a common set of risks (credit risk – including securitisations – market risk and counterparty credit risk, operational risk – including conduct risk). In addition, banks are requested to project the effect of the scenarios on net interest income and to stress P&L and capital items not covered by other risk types. The current draft methodology can be seen as a continuation of the 2016 approach, with the adjustments identified after the IFRS 9 implementation and 2016 lessons learnt.

 

The draft methodology is the starting point for an informal discussion with banks so as to receive their input, which will be taken into account when finalising both documents. For this purpose, explicit questions for banks have been included in the draft methodological note for every topic.

 

The process

The 2018 EU-wide stress test will be run in close cooperation with  the EBA, Competent Authorities (including the Single Supervisory Mechanism – SSM), the European Central Bank (ECB), the European Systemic Risk Board (ESRB) and the European  Commission. Scenarios, methodology, minimum quality assurance guidance and templates will be agreed by the EBA's Board of Supervisors. The macroeconomic adverse scenario and any risk type specific shocks linked to the scenario will be developed by the ESRB and the ECB in close cooperation with Competent Authorities and the EBA.

 

The EBA will coordinate the exercise and will act as the data hub for the dissemination of detailed results on a bank-by-bank level. The EBA will also provide aggregate analyses and tools in line with its commitment to enhancing the transparency of the EU banking sector.

 

Competent Authorities will be responsible for conveying the instructions to banks on how to complete the exercise as well as for receiving banks' data. In addition, they will be responsible for validating banks' data and stress test results based on the bottom-up calculation as well as for reviewing the models applied by banks for this purpose. Finally, they will also be responsible for activating any supervisory reaction function, if needed.