22 January 2020

Financial Times: European Banking Authority plans overhaul of EU bank stress tests

The watchdog argues that the current methodology — introduced in the wake of the financial crisis to show how much capital would be depleted if a lender came under pressure — has outlived its usefulness.

In proposals floated, the EBA, which ensures bank regulations are applied evenly across the EU, said it to wanted to focus instead on how banks use their capital in more “relevant” scenarios.

It wants lenders across the bloc to have more control over how they model results, with the ability to cast aside existing constraints if they explain why, according to its discussion paper.

“The framework we are proposing today aims at making the EU-wide stress test more informative, flexible, and cost-effective,” said José Manuel Campa, the EBA’s chairman.

Separate sets of results would be published under the plans: one from the supervisors and one from the banks, with the banks having to explain any discrepancies. While banks would have to give far more detail than is now the case, the supervisors would be required to give less.

The EBA argues that the planned redesign would give more information than similar tests in the UK and the US. Its current stress tests have been judged by markets to be the most lenient because there is no pass or fail benchmark and there is a lag between the publication of results and any supervisory follow-up in terms of ordering action that a bank should take.

Simon Gleeson, a regulatory partner at law firm Clifford Chance, said the EU and the US operated almost diametrically opposed exercises.

“What the EBA is saying here is that they want banks to do in effect a parallel stress test, in which they take into account how they would actually respond to the stress, and assess what the impact would be after those responses,” he said. “The result of the bank’s parallel test will by definition be a lower number than the supervisor’s test.”

Full article on Financial Times (subscription required)

Related consultation: 

EBA consults on the future of the EU-wide stress test framework

The European Banking Authority (EBA) launched today a public consultation on possible future changes to the EU-wide stress test. This discussion paper aims to present the EBA’s vision of the future of the EU-wide stress test and to collect comments and feedback from the different users. “The framework we are proposing today aims at making the EU-wide stress test more informative, flexible, and cost-effective, said the EBA Chairperson, Jose Manuel Campa, in launching the consultation. Campa added, “It is the first time we embark on a comprehensive discussion on the future of EU stress testing and we are keen to receive feedback from a wide range of stakeholders”.  The consultation runs until 30 April 2020.

Key features of the new framework                       

Since 2011, the EU-wide stress test has contributed to improving banks’ resilience after the financial crisis, has enhanced transparency and has been instrumental in restoring trust in the EU banking sector. The proposed new framework tries to balance the need to preserve comparability and conservatism, while allowing for more flexibility in order to identify banks’ idiosyncratic risks.

The proposal envisages two components owned by supervisors and banks respectively: the supervisory leg and the bank leg. The supervisory leg serves as the starting point for supervisory decisions and would be directly linked to the setting of Pillar 2 Guidance (P2G). The bank leg, on the other hand, allows banks to communicate their own assessment of risks in an adverse scenario.

To ensure a certain level of comparability, both legs would use the same common scenarios and starting points for projecting the stress test results.

The supervisory leg would be based on a common EU methodology, in line with the current constrained bottom-up approach but with the possibility for competent authorities to adjust or replace banks’ estimates based on top-down models or other benchmarking tools.

The methodology for the bank leg would be less prescriptive than today and give banks more discretion in calculating their projections. In practice, banks would use the same common methodology as in the supervisory leg, but would be allowed to relax the methodological constraints to the extent they can explain and disclose the rationale and impact of such deviations.

Discussion Paper on the future changes to the EU-wide stress test

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