FT/Keohane: Stress tests in Europe

30 April 2014

Writing for the FT Alphaville Blog, David Keohane argues that stress tests in Europe maybe are not the mugging by reality they used to be but instead are putting up a little bit more of a fight this time.

He quotes Citi putting the European Banking Authority’s recently released methodology against the US’s CCAR:

In the EU, the proposed adverse scenario leads to an overall cumulative deviation of EU GDP from its baseline level by 7 per cent over the 3-year period to end-2016, with EU unemployment deviating by 2.9 per cent versus the baseline scenario. This would imply a cumulative real GDP decline of -2.1 per cent over 3-years, notably less than the stress applied in the US CCAR (a -4.75 per cent decline over 15 months) and a peak unemployment rate of 13.0 per cent versus US CCAR 11.25 per cent. Equity prices are expected to decline by 19 per cent relative to the baseline (US CCAR -50 per cent decline), residential house prices by -21 per cent (US CCAR -25 per cent) and commercial property prices by -15 per cent (US CCAR -35 per cent).

Also, no deflation in the EU adverse scenario? And that’s with the EBA pencilling in a larger drop in GDP growth than in 2011. A surprising resilience to collapsing growth and a nod to stickier inflation, or a misunderstanding of the word stress? Maybe, as Societe Generale says, this points to the difficulties in designing realistic scenarios (without affecting expectations), with success only possible to establish ex post. The author thinks that means the EBA, when designing any stress test, has to hold fire for fear of spooking tender souls.

But he also thinks that means missing the point of a stress test — it’s supposed to look past the realistic scenarios to the kind of scenarios that would make a bank cry.

Full blog post


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