Key components for the 2014 European banking stress tests that will be done on a wide selection of European Union (EU) banks have been announced by the European Banking Authority (EBA).
The aim of the European banking stress tests is to help supervisors decide how resilient financial institutions are to adverse market developments.
The tests aim at making sure there is “consistency and comparability of the outcomes across all banks based on a common methodology, scenarios and accompanied by a consistent disclosure exercise,” the EBA wrote in an online communique.
The European banking stress tests, known as the 2014 EU-wide stress test, is designed to provide institutions, market participants and supervisors with consistent data to compare and contrast the resilience of EU-banks under adverse conditions.
“To this end,” says the EBA “we will provide competent authorities (CAs) with a consistent and comparable methodology, which will allow them to undertake a rigorous assessment of banks’ resilience under stress.”
Stress tests gauge Banks’ resilience under adverse conditions
The exercise has been designed in coordination with the ECB, which in preparation of the SSM (Single Supervisory Mechanism) is carrying out a comprehensive assessment consisting of a stress test, asset quality review and a risk assessment.
The stress test will be conducted on a EU-wide representative sample of 124 banks which cover more than 50% of each country’s national sector, “and will be run at the highest level of consolidation.”
The ECB added “Given its objectives, the 2014 EU-wide stress test will be conducted under the assumption of a static balance sheet which implies no new growth and constant business mix and model throughout the time horizon of the exercise.”
Several risks will be placed under stress
A common set of risks will have to be stressed, these include:
- credit risk
- market risk
- sovereign risk
- cost of funding.
Trading and banking book assets will also be subject to stress, as well as off-balance sheet exposures. Competent authorities may add further risks and country-specific vulnerabilities beyond this common set. The ECB added “The published results should allow understanding the impact of the common set of risks in isolation.
As far as capital thresholds are concerned, for the baseline scenario the capital hurdle rate will be set at 8% Common Equity Tier 1 (CET1), and 5.5% CET1 for adverse scenarios.
Relevant competent authorities may set higher hurdle rates and formally commit to take specific measures or actions on the basis of those more stringent requirements.
The EBA, the European Central Bank and competent authorities will liaise closely during the running of the exercise.
The EBA wrote “In particular, the EBA will be responsible for coordinating the exercise in cooperation with the ECB (in case of SSM countries) and ensuring effective cooperation between home and host supervisors. Furthermore, the EBA will provide pan European benchmarks and will act as a data hub for the final dissemination of the common exercise. On the other hand, CAs will bear responsibility for overseeing the exercise with the banks and checking the quality of the results.”
Dates of publications:
- The methodology and scenario – April 2014.
- Banks’ individual results – end of October 2014.