Banking sector stress tests in the EU* Reiner Martin Deputy Head of Division Macro-Financial...
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Banking sector stress tests in the EU* Reiner Martin Deputy Head of Division Macro-Financial Linkages European Central Bank Mendel University Brno 16 October 2015 *The views presented in this paper are exclusively those of the authors and not necessarily those of the ECB.
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Transcript of Banking sector stress tests in the EU* Reiner Martin Deputy Head of Division Macro-Financial...
Banking sector stress tests in the EU*
Reiner MartinDeputy Head of DivisionMacro-Financial LinkagesEuropean Central Bank
Mendel University Brno16 October 2015
*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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• 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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• 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 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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The ECB top-down stress testingThe ECB’s top-down stress testing framework
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A. ECB Stress Testing Framework: Overview
Scenario Balance sheet FeedbackSatellite models
Macromodels
Credit riskmodels
Profitmodels
Market risk and securitisationmodels
Loan lossmodels
Balance sheet and P&L tool =>Solvency
Contagionmodels
Macrofeedbackmodels
Financial shocks
Dynamic adjustment
model
Funding shock
RWA
Top-down banking sector stress testing framework
Forward-looking solvency analysis
6Sources: Henry and Kok (eds.), ECB Occasional Paper 152, October 2013.
The ECB top-down stress testing frameworkThe ECB’s top-down stress testing framework
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Cross-country macro scenario design has to balance various factors:Adherence to macro-financial story lineModel-based versus expert-based approach to shock-calibrationModel 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 assumptionsCross-check: use top-down stress test framework during bottom-up scenario design process to gauge severity
A. ECB Stress Testing Framework: OverviewThe ECB top-down stress testing frameworkThe ECB’s top-down stress testing framework
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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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The ECB top-down stress testing frameworkThe ECB’s top-down stress testing framework
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Satellite models
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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
The ECB top-down stress testing frameworkThe ECB’s top-down stress testing framework
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Overview of solvency calculation
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Solvency ratio(minimum threshold)
Existing capital
Risk weighted assets
Net operating income
Input from profitand loss module
Input from RWA module
potential capital shortfall
Definition of capital (country specific)
≤+
The ECB top-down stress testing frameworkThe ECB’s top-down stress 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 top-down stress testing frameworkThe ECB’s top-down stress 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 ECB top-down stress testing frameworkThe ECB’s top-down stress testing framework
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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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DRAFTThe Comprehensive Assessment 2014
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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
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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 CET1.15
The Comprehensive Assessment 2014
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Capital shortfall by country
Total shortfall (€ BN)
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
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The Comprehensive Assessment 2014
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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
The Comprehensive Assessment 2014
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Source: Bloomberg
The Comprehensive Assessment 2014
Bank equity prices came closer to those of other firms
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Source: Datastream
Decoupling banks from sovereigns
The Comprehensive Assessment 2014
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• 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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Balancesheet
Loan losscalculation
Profit and loss calculation
Net interest income
Balance sheet
assump-tions
Input frominterest rate
models
Interest Income
and expenses calculation
Loan lossand
impairmentcalculation
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
= NET INCOME/LOSS
Input for other income/expense
components
Evolution of main balance sheet items
Input from loan lossmodels
Foregone interest income on NPL
Marketrisk
Tradingincome
Input from
variousmodels
Overview of P&L calculation
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The ECB top-down stress testing frameworkThe ECB’s top-down stress testing framework
