Reiner Martin
Deputy Head of Division
Macro-Financial Linkages
European Central Bank
Mendel University Brno
16 October 2015
Banking sector stress tests
in the EU*
*The views presented in this paper are exclusively those of
the authors and not necessarily those of the ECB.
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Outline
• Introduction and terminology
• Banking sector stress tests at the ECB/SSM
• The ECB top-down stress testing framework
• The Comprehensive Assessment 2014
• Outlook
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Introduction
terminology
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ECB-RESTRICTED
DRAFT
• Banking sector stress tests gained significantly in importance since
the start of the financial crisis in 2007/08
• On-going debates / discussions with(in) ECB/SSM, EBA,
NCAs/NCBs, IMF…as well as in the financial sector itself!
• Terminology
– (Constrained) Bottom-up vs. Top-down
– Solvency vs. Liquidity
– Contagion / Networks
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Banking
sector
stress
atmaster
the ECB / SSM
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ECB-RESTRICTED
DRAFT
• Top-down – for macroprudential purposes
– Quarterly risk impact assessment for the ESRB (EU-wide)
– Bi-annual corresponding exercise for the Financial Stability Review (public)
– Regular macroprudential impact assessment for the Eurosystem
• Top-down for system-wide exercises
– (Crisis) country-specific and SSM-wide
• Bottom-up – for microprudential purposes
– SSM-wide (banks' results for publication)
– Input into regular bank-specific supervision (SREP)
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The
ECB’s
top-down
stress
testing
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The
top-down
testing
The ECB’s top-down stress testing framework
Key features of the model:
• Uses granular data of around 130 large SSM banks
• Is contingent on a macroeconomic scenario
• Accounts for direct impact on banks’ balance sheets
• Is complemented with modules to take into account :
• Dynamic reaction of banks to macro-prudential
policies
• Contagion across banks
• Macroeconomic models accounting for second round
effects on the real economy
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A.
ECB
Stress
Testing
Framework:
Overview
The
ECB’s
top-down
stress
testing
framework
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The
top-down
testing
framework
Top-down banking sector stress testing framework
Forward-looking solvency analysis
Scenario
Funding
shock
Financial
shocks
Macro
models
Satellite models
Balance sheet
Feedback
Loan loss
models
Credit risk
models
Market risk and
securitisation
models
Profit
models
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Sources: Henry and Kok (eds.), ECB Occasional Paper 152, October 2013.
RWA
Contagion
models
Balance sheet and
P&L tool =>
Solvency
Dynamic
adjustment
model
Macro
feedback
models
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A.
ECB
Stress
Testing
Framework:
Overview
The
ECB’s
top-down
stress
testing
framework
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The
top-down
testing
framework
Cross-country macro scenario design has to balance various
factors:

Adherence to macro-financial story line

Model-based versus expert-based approach to shock-calibration

Model consistency vs. ad hoc assumptions

Need to ensure substantial stress being imposed on all banks in
the exercise?

A mixture of model-based and judgemental assumptions

Cross-check: use top-down stress test framework during bottom-up
scenario design process to gauge severity
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The
ECB’s
top-down
stress
testing
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The
top-down
testing
framework
Elements of the scenario design
 EU macro: “Stress Test Elasticities” (STE)
 Multi-country EU-wide shock simulation tool based on impulse
response functions (from EU central banks’ models) of endogenous
variables to pre-defined exogenous shocks
 Allow for country-specific shocks and incorporate EU-wide
spillovers (via a trade link block)
 CRE prices outside the system and modelled by satellite equations
 Non-EU macro: external models (e.g. NIGEM)
 A separate toolbox is used to derive pure financial shock
scenarios: non-parametric copula approach to simulate
joint/multivariate forward distribution of financial variables (model free,
can handle large # variables)
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ECB’s
top-down
stress
testing
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The
top-down
testing
framework
Satellite models
Credit risk:
•
•
Estimation of country aggregate, product-specific model equations
LGD model based on stressed collateral values and LTV ratios (a function of house prices)
Net interest income:
•
•
Estimation of country aggregate, product-specific model equations
Models for retail interest rates and for wholesale funding costs
Other pre-provision income:
•
•
Based on assumptions rooted in EBA methodology
Fee & commission income model (bank panel regression framework)
Market risk and securitisation:
•
•
•
Asset shock calibration (distinguishing between Held for Trading and Available for Sale / portfolios)
Projections of Credit Valuation Adjustments (CVA)
Projection of securitisation book using rating migration matrices
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The
ECB’s
top-down
stress
testing
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The
top-down
testing
framework
Overview of solvency calculation
Input from profit
and loss module
Definition of capital
(country specific)
Existing capital
Solvency ratio
(minimum threshold)
≤
+
Net operating
income
Risk weighted assets
potential
capital shortfall
Input from RWA module
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The
ECB’s
top-down
stress
testing
The
top-down
testing
framework
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Interbank network and contagion models are used to:
• Select relevant interbank networks of direct exposures
– Static network: can be based on observed networks (e.g. EBA
collection, Target 2) or simulated networks (Hałaj & Kok (2013,2015))
– Dynamic network: changes in the network take changes in market
parameters impacting banks’ counterparty credit risk into account
• Simulate default cascades, initiated by banks with shortfalls projected
by the BST
– Knock-on (domino) effects: default causes other defaults (based on
LGD assumptions);
– Clearing payment: equilibrium payment after all flows of payments
stabilise (endogenous LGD)
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The
ECB’s
top-down
stress
testing
The
top-down
testing
framework
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Macro feedback models
Used to calculate the impact of the changes in bank balance sheets on
macroeconomic variables (GDP, investment, consumption, housing, etc.)
1) Vector autoregressive models (GVAR/VAR): estimate endogenous
relationships between real and financial variables including proxies for
regulatory/macro-prudential measures, such as capital and liquidity
ratios. (Gray, Gross, Paredes and Sydow (2013), Gross (2013), Gross
and Kok (2013) )
2) Dynamic general equilibrium models: derive macroeconomic and
financial relationships from microeconomic principles modelling directly
the pass-through mechanism of shocks to macroeconomic and financial
variables. (Żochowski (2014), Darracq Pariès, Kok and Rodriguez
Palenzuela (2011))
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The
Comprehensive
Assessment
3.2
back
to the
STmaster
bit2014
– combination of the 2
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ECB-RESTRICTED
DRAFT
Key features of the Comprehensive Assessment 2014
• One-off exercise: starting point for and pre-condition to SSM
• Next time will be different – now the SSM is there!
• Timeline, methodology, templates, publication (largely) in common
with EBA
• 2 Components - an Asset Quality Review and a constrained
bottom-up stress test with top-down quality control
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The
Comprehensive
Assessment
2014
4.2.
projected
to decrease
4%
under the adverse scenario
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Reduction in bank capital ratios under the adverse scenario
SSM
median: 4.0%
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The
Comprehensive
Assessment
2014
4.4.
theline
adverse,
SSM
average
CET1 declines from 11.8 to 8.8%
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Breakdown of aggregate impact of ST under the adverse
scenario
1.
Weighted means; excluding the AQR impact on starting point capital
NB: LLP and NII key drivers to the deviations from baseline CET1.
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The
Comprehensive
Assessment
2014
4.3.
least
with
capital
shortfall
in 11 of the 19 countries
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Capital shortfall by country
Total
shortfall 2.37 8.72 1.14 9.68 0.07 0.86 0.87 0.54 0.23 0.13 0.03 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
(€ BN)
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The
Comprehensive
Assessment
2014
5.2.
Comparing
and
Top-Down
results
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ECB-RESTRICTED
DRAFT
Top-down vs. Bottom-Up results
• Top Down results were generally somewhat more “conservative”
• So called ‘Quality Assurance Process’ led to gradual convergence
of results over time
• Supervisory dialogues meetings bridged the remaining gap at the
end of the process
• Top-down results helped the QA process and ultimately helped to
boost credibility of the SSM banking sector
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The
Comprehensive
Assessment
2014 banks closer to other firms
5.3.
Around
– The
exercise
brought
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Bank equity prices came closer to those of other firms
Source: Bloomberg
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The
Comprehensive
Assessment
2014
5.5.
Around
– Decoupling
banks
from sovereigns
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Decoupling banks from sovereigns
Source: Datastream
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Outlook
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ECB-RESTRICTED
DRAFT
• The ECB/EBA banking sector stress test 2016 will again be a
constrained bottom-up exercise with top-down-driven QA (but no
AQR!)
• Other countries follow different approaches, e.g. the US
• Stress test ‘construction sites’:
– Solvency stress tests
– Stress tests for non-bank financial firms (insurers, pension
funds, ‘shadow banks’)
– Network analysis (within sectors and beyond)
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Annex slides
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The
ECB’s
top-down
stress
testing
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The
top-down
testing
framework
Overview of P&L calculation
Balance
sheet
Evolution
of main
balance
sheet
items
Net interest
income
Interest
Income
and
expenses
calculation
Loan loss
calculation
Loan loss
and
impairment
calculation
Market
risk
Trading
income
Profit and loss
calculation
Net interest income
+ Net fee and commission
+ Net trading income
– Staff expenses
– Depreciation and amortization
– Administrative expenses
– Other net operating income
= OPERATING PROFIT/LOSS
– Provisions on loans and advances
– Other provisions (e.g. financial
assets, goodwill)
= PROFIT/LOSS BEFORE TAXES
– Taxes
– Minority interest
Foregone interest
income on NPL
= NET
Balance
sheet
assumptions
Input from
interest rate
models
Input from
loan loss
models
2
Input
from
various
models
INCOME/LOSS
Input for other
income/expense
components
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