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The financial and sovereign debt crises have highlighted how important it is for banks to have solid capital buffers that enable them to withstand extreme and unexpected shocks to their balance sheets and thus ensure that they can act as effective financial intermediaries even in periods of turbulence. A macro stress-testing framework is often used to assess in a forward-looking manner the resilience of the banking sector to (adverse) macroeconomic and financial developments. In line with its responsibility for safeguarding financial stability in the euro area, the ECB also employs macro stress-testing tools in its regular macro-prudential assessments. Furthermore, macro stress-testing will be an integral part of the ECB’s activities in relation to its future role as a single bank supervisor for the euro area.
This paper provides a comprehensive and detailed description of the analytical framework employed by the ECB in a top-down manner for macro stress-testing of banks’ solvency. This work is done to support its contribution to safeguarding financial stability and its financial sector-related work in the context of EU/IMF Financial Assistance Programmes, and to challenge results from bottom-up stress tests conducted by banks and their supervisors. Furthermore, the stress-testing framework can be used for both micro and macro-prudential purposes once the ECB takes up its supervisory powers in the context of the establishment of the Single Supervisory Mechanism (SSM). The paper is structured as follows:
Chapter 1 of this paper reviews the motivations for conducting macro stress tests and briefly summarises the recent institutional history in terms of who conducts macro stress tests at the global and European levels. Finally, it surveys the main objectives and challenges that stress testers face and that need to be considered when constructing an analytical framework for macro stress testing purposes.
Chapter 2 presents the bank solvency analysis framework developed and used at the ECB for top-down macro stress-testing purposes. The framework consists of four pillars; namely, the macro-financial scenario design, models to translate scenarios into impacts on banks, the solvency calculation module, and a module for contagion and feedback analysis. The framework is thus based on a number of different building blocks and models that are linked together consistently and dynamically to provide a flexible tool for assessing banking sector resilience against identified systemic risks.
The stress-testing tool is employed for different purposes and in various contexts. Chapter 3 provides illustrative examples and descriptions for how the framework is used in regular financial stability analysis and also how the tool can be used in the context of challenging results from bottom-up stress tests.
Chapter 4 concludes.