MACRO STRESS TESTS IN A
SIMPLIFIED SPREADSHEET
APPROACH
MINDAUGAS LEIKA
CONTENTS
Balance sheet STs: basics
Simple Balance Sheet ST model: Stress Tester v2 (Cihak, 2007)
Case study from the WP: Bankistan
Questions: ST scenarios
2
Questions: ST results
BALANCE SHEET STS: BASICS
(1)
Under balance sheet approach, we stress banks’ assets,
liabilities, income and expenses. This is data intensive approach,
however allows us to have detailed analysis and assumptions of
various items on balance sheet and P&L statements.
3
We calculate capital as follows:
BALANCE SHEET STS: BASICS
(2)
Loan loss
Current
Tier I and II
capital
(regulatory
capital)
Current RWA
for: credit,
market and
operational
risks
Satellite credit
growth model
Migration matrices
provisions;
Forecasted from
satellite credit
loss model
Loan loss
provisions;
Forecasted from
satellite credit
loss model
4
Net income before
loan loss provisions;
Forecasted from
satellite income
model
STATIC VS. DYNAMIC APPROACH
Dynamic STs take into account previous quarter P&L statement
and applies results to generate the next quarter’s balance sheet
and so on.
We model both, income statement and balance sheet.
Static approach ,might be used to compare forecasted quarter's
results with the base quarter.
In dynamic framework we see, whether a bank is above CAR at
any given point in time or not, while under static approach we
might miss some periods where bank has CAR below target as
losses/profits are non-cumulative.
5
Static framework shows us the difference between the forecasted
period and the base period.
STATIC VS. DYNAMIC APPROACH
Dynamic approach
Starting Balance
sheet Q0
• Profit and
loss
statement Q1
Balance sheet
Q1
• Profit and
loss
statement Q2
Balance sheet
Q2
• Profit and
loss
statement Q3
Static approach
• Profit and
loss
statement Q1
Starting balance
sheet Q0
• Profit and
loss
statement Q2
Starting balance
sheet Q0
• Profit and
loss
statement Q3
6
Starting balance
sheet Q0
STRESS TESTER V2 FEATURES
Very simple, beginner’s framework, though good starting point
One period model. By default, assumes annual input data
No satellite models
Assumptions, shock scenarios have to be calibrated outside of the
framework
 Contains the following worksheets: Read Me, Data, Assumptions,
Credit Risk, Interest Risk, FX Risk, Interbank, Liquidity, and Scenarios
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Color scheme:
STRESS TESTER V2 FEATURES
Variables which can be stressed in the model:
1.
Capital – capital on terms of $
2.
Capitalization – CAR (equity to assets, equity to RWAs)
3.
Capital injection – absolute number and in terms of GDP
4.
Profits – net income before and after provisions
5.
Profitability – return on assets, equity (ROA, ROE)
6.
Net interest income
7.
Z-scores – default probability and distance to default
8.
Loan losses – provisions
9.
Liquidity indicators
10. Ratings and PDs
bank rated 2 fails with a 1 percent probability; a bank rated 3 has a 5 percent probability of
default, and a bank rated 4 has a 30 percent probability of default in the coming year.
1
Probability of default (%)
5
30
LINK BETWEEN CAR AND PD IN THE
EXCEL FILE Figure 2. ‘Step Function’ (Example)
0
5
8
15
Capital adequacy ratio (%)
Source: the author, based on the default settings in the “Assumptions” sheet
Source: Cihak, WP07/59
CASE: BANKISTAN (1)
The economic environment in which banks are operating in
Bankistan is challenging, with increasing macroeconomic
imbalances, inappropriate macroeconomic policies, and deep
uncertainty fueled by political tensions. Real activity is sharply
contracting, and inflation has almost doubled to 65 percent.
Unsustainable fiscal imbalances and loose monetary conditions
were key to the deteriorating situation in Bankistan. The government
deficit more than doubled in 2005, and a sharp increase in central
bank financing of the government has significantly accelerated
money growth.
The policy response to the deteriorating situation has been
inappropriate. Expansionary monetary policy measures (e.g., a
lowering of reserve requirements) have induced a further easing of
liquidity conditions. The ensuing excess liquidity induced a drop in
treasury bill rates from 60 percent to below 15 percent. This means
that together with an inflation rate of 65 percent, real interest rates
are sharply negative. (Note: This is used for assessing interest rate
risk.)
Source: Cihak, WP07/59
CASE: BANKISTAN (2)
The official exchange rate of the Bankistan currency, Bankistan
dollar (B$), is fixed at 55 B$/US$. However, the black market
exchange rate has depreciated in recent months from about 60
B$/US$ to about 85 B$/US$. (Note: This is important information
for assessing foreign exchange risk.)
The deteriorating macroeconomic environment has put
considerable strain on the financial condition of the banking
system. Even though the system has proved so far to be
remarkably resilient, some banks have been weakened
considerably, and are prone to further deterioration in light of the
significant risks. Reported high capital adequacy ratios were
found to be overstated due to insufficient provisioning. (Note: This
information is used for the assessment of asset quality.) In
addition, asset quality has deteriorated. The ratio of gross
nonperforming loans (NPLs) to total loans has increased from 15
percent at end-2004 to 20 percent at end-2005. (Note: This
information will be used for assessing credit risk.)
Source: Cihak, WP07/59
CASE: BANKISTAN (3)
The banking system of Bankistan consists of 12 banks. Three of
them are state owned (with code names SB1 to SB3), five are
domestic privately owned banks (DB1 to DB5), and four are
foreign- owned (FB1 to FB4). The banking system, and
particularly the state-owned banks, have been plagued by a large
stock of NPLs and weak provisioning practices. Data on the
structure and performance of the 12 banks are provided in the
“Data” sheet of the accompanying Excel file. An assessment of
Bankistan’s compliance with the Basel Core Principles for
Banking Supervision (BCP) suggests that even though existing
loan classification and provisioning rules in Bankistan are broadly
adequate, they are not well implemented in practice and banks
are underprovisioned.
Source: Cihak, WP07/59
CASE: BANKISTAN (4)
Given that Bankistan as an emerging market country faces more
risks than an industrial country, it is appropriate to require from
banks a higher CAR. Based on these considerations, Bankistan’s
supervisors use a minimum CAR of 10 percent. Whenever the
CAR of a bank in Bankistan falls below 10 percent, its owners are
obliged to inject capital in order to stay in business.
KEY ISSUES FOR
DISCUSSION: SCENARIOS (1)
a) Based on economic environment in Bankistan, which risks you
think are most important and plausible?
Shock matrix
High probability
Low probability
High impact
Main focus
Watch
Low impact
Summary mention
Ignore
KEY ISSUES FOR
DISCUSSION: SCENARIOS (2)
b) What is the size of shocks?
c) Which shocks are related?
KEY ISSUES FOR
DISCUSSION: CREDIT RISK
Credit shock 1 (“Underprovisioning”)
(1) Which banks would be undercapitalized or even insolvent after
applying the provisions?
(2) How much capital would the government need to inject in
order to bring the capital asset ratio of the
undercapitalized/insolvent banks up to the required minimum of
10 percent?
Questions are from Cihak (2007) IMF WP 07/59
KEY ISSUES FOR
DISCUSSION: CREDIT RISK
Which banks can not withstand a 25 percent increase in NPLs
and will be undercapitalized or fail in this event?
(3) How much capital would the government need to inject in
order to bring the capital asset ratio of the
undercapitalized/insolvent banks up to the required minimum of
10 percent?
(4) What happens if only assets with a risk-weight of 0 percent,
i.e. government bonds, would be affected?
(5) Discuss alternative assumptions regarding the increase in
NPLs and how these can be implemented.
KEY ISSUES FOR DISCUSSION:
INTEREST RATE RISK
(6) Which banks can withstand the increase in interest rates and
which would fail?
(7) What are the associated potential costs for the government
given the failure of banks in times of stress?
(8) What are the weaknesses of the interest rate risk calculations
and how can they be remedied?
KEY ISSUES FOR DISCUSSION:
EXCHANGE RATE RISK
(9) Which banks can withstand the shock and which would fail or
be undercapitalized?
(10) What are the associated potential costs for the government
given the failure of banks in times of stress?
(11) How does the inclusion of the indirect FX risk change the
result of this stress tests?
(12) How can the incorporation of the indirect FX risk be made
even more realistic?
KEY ISSUES FOR DISCUSSION:
CONTAGION RISK
(13) How would you calculate the impact of the third iteration in
the “pure” contagion exercise?
(14) How would you incorporate banks’ profits into the exercise?
(15) How would you reflect in the exercise the fact that banks with
positive, but small, capital adequacy ratios can also fail?