ECB: Macroprudential stress-tests and tools for the non-bank sector

22 September 2017

ECB's Vítor Constâncio spoke about what needs to be improved to operationalise stress testing and about the state of play regarding the implementation and progress made for some of the specific macroprudential instruments that authorities would need, should systemic risks materialise.

Assessing the impact of a large shock on financial soundness of non-bank financial institutions, stress testing can improve measurement of the risks and can help in the calibration of instruments mitigating those risks. There is a need to further develop these policy tools while at the same time adaptation of stress test models towards integrating different agents into a system-wide tool is important.

The ESRB - in its strategy paper on macroprudential policy beyond banking, for example, emphasises the need to develop a wider financial stability toolkit, including top-down stress tests, for example, for asset managers, the need to operationalise macroprudential instruments for which a legal basis has already been created or the need to investigate the potential for increasing the consistency of available macroprudential instruments across sectors.

In its report on stress test analytics for macroprudential purposes in the euro area, the ECB also outlines the plans for extending stress testing into other sectors, most prominently the shadow banking sector, but also into the stress testing of central counterparties and insurance and pension funds.

Mr. Constâncio first sets the stage by reiterating the two main systemic risks stemming from the non-bank financial sector:

• First, the increasing size and growth of the euro area investment fund sector has the potential to amplify financial stability risks, both in terms of liquidity and leverage.
• Second, the procyclical nature of margin and haircut-setting practices of market participants and liquidity risk propagation in collateralised securities financing and derivatives transactions is a concern for financial stability.

So the questions arise: how to appropriately measure these risks and how to derive policy instruments that are effective in mitigating these risks? What are the challenges for macroprudential stress tests to provide meaningful indicators to measure and predict the level of systemic risk, the position of the economy in the financial cycle and consequently the adequate stance of macroprudential policies?

In recent years, stress testing has become an increasingly prominent approach to gauging impact of a large shock on the agents’ financial soundness and on the market functioning. However, stress testing tools for non-banks are still in a fledgling state, in particular in how they capture system-wide effects.

Mr. Constâncio elaborates on what needs to be improved to operationalise them:

• First and foremost, in order to conduct proper stress test analysis for the non-bank financial sector, data availability needs to be significantly improved.
• As far as the second enhancement is concerned, existing non-bank stress test approaches need to better account for interactions between agents.
• Third, as their business models and behaviour differ from traditional banks, specificities of non-bank financial institutions have to be considered carefully when designing tools to stress them.

Mr. Constâncio then turns to the state of play regarding the implementation and progress made for some of the specific macroprudential instruments that authorities would need, should systemic risks materialise:

• On the global level, the 2017 FSB policy recommendations on asset management structural vulnerabilities, now being operationalised by IOSCO, are expected to reduce liquidity mismatches in open-ended funds. Importantly, recommendation 8 captures the potential macroprudential role for authorities to provide direction on the use of liquidity risk management tools (e.g. suspension of redemptions) by funds in extraordinary circumstances. In the area of liquidity mismatch, the recommendations also address the potential use of system-wide stress testing by authorities. Leverage recommendations focus on the measurement and monitoring of leverage within investment funds, including data for synthetic leverage calculation.
• On the European level, on-going work of the Expert Group on Investment Funds (EGIF) develops recommendations that are addressed to funds and asset managers. Given that the investment fund sector is growing relative to the financial system as a whole, the ESRB is analysing systemic risks posed by liquidity mismatch and leverage in the types of investment funds exposed to these risks.

Mr. Constâncio concludes by saying that despite the progress made, there is more work to be done: on the operationalisation of tools, on further improving data or the interaction with the policy and research community to enhance stress testing models. He would therefore encourage authorities, including the European Commission, the ESRB but also ESMA to continue to contribute towards this goal.

Full speech

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