Stress Test – Assessment of the Risk Situation of Credit Institutions

As part of the SREP (Supervisory Review and Evaluation Process), the European banking supervisory authority continuously assesses the risk situation of the supervised institutions and – if necessary – specifies measures for mitigating risk, which must be implemented accordingly by the credit institutions in question. In support of the SREP, the banking supervisory authority regularly conducts stress tests to examine the stability of credit institutions in certain crisis scenarios. The focus is on the ability of institutions to cushion shocks in an unfavorable macroeconomic environment and to meet capital requirements.

Stress Tests by the ECB

Stress tests were carried out by the EBA and the ECB in 2014, 2016, 2017 and 2018. The 2018 test is based on IFRS 9 data for the first time. In the crisis scenario, the test includes a decline in economic output and price levels, a slump in the real estate markets and a rise in unemployment. A total of 37 European credit institutions are affected by the stress test, including eight German banks. In 2017, the ECB focused its stress test on interest rate risks in the banking book against the backdrop of the prevailing low interest rate environment. A total of 111 credit institutions took part in this test. In addition to the credit institutions primarily affected by the EBA stress test, there are also other institutions affected in practice since comparable scenarios and requirements under the SREPs and ICAAPs are regularly required from all institutions.

The Latest Stress Test 2018-2020

The EU-wide stress test in 2018 was developed by the EBA in cooperation with the ESRB (European Systemic Risk Board). It comprises 28 templates for data acquisition, calculation and validation and 10 templates for publishing the results at the institute group level. The starting point is the values as of December 31, 2017 (or January 1, 2018). A base scenario and a negative scenario are projected from this starting point over three periods (2018-2020). The basis for the entire period is the accounting set applicable as of January 1, 2018. Financial assets and liabilities must therefore be measured and reported in accordance with IFRS 9. No further changes to the accounting standards need to be taken into account. For historical values through 2017, it is sufficient to use the balance sheet values valid for this period unless the values are restated.

Both the base scenario and the adverse scenario are to be determined under the assumption of a constant balance sheet. This means that expiring transactions must be replaced by transactions that have the same residual term (based on Jan. 1, 2018 of the expiring transaction) and the same credit quality (based on the maturity date of the expiring transaction).

Effects are reported on the basis of the CET1 capital, Tier 1 capital ratio and total capital ratio for each of the three periods, both “fully loaded” (i.e. after the complete implementation of the Basel III capital requirements) and also “transitional” (i.e. the capital requirements applicable in the transition period). No minimum thresholds or further capital ratios are defined beyond the requirements of the CRR. However, the results must be taken into account as input metrics in the SREP process.

Fundamental Challenges in Stress Tests

The following challenges regularly arise in the practical implementation of stress tests:

• Provision of actual data as a starting point for further processing, including elimination of any future-oriented valuations already included.
• Modelling of the business volume or the business structure over the term depending on the guidance.
• Application of stress scenarios to the business portfolio and determination of the effects on earnings and capital

WTS Advisory Support in the Context of Regulatory Stress Tests

WTS Advisory supports credit institutions in the planning and implementation of stress tests. In the phase of defining methods and tools, we analyze the guidance provided by the supervisory authorities and identify/define responsibilities and delivery channels in the banks. In the course of data collection, the required initial values are determined from the existing reporting. Here we use our extensive experience with IFRS 9 and FINREP to consistently use existing underlying data as a starting point for the stress test. In addition, WTS Advisory supports the projection of scenarios and the internal validation of determined stress test results.

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