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CEBS Consultation Paper 12 Summary on Stress Testing Under the Supervisory Review Process

Core Content

CEBS Consultation Paper 12 (CP12) focuses on the design and application of stress testing within the Supervisory Review Process (SREP) and the Internal Ratings-Based Approach (IRBA). The paper aims to provide principles for stress testing rather than detailed regulatory requirements. The ZKA (Zentraler Kreditausschuss), representing over 2,300 German banks with a consolidated balance sheet of approximately EUR4.8 billion, has provided detailed comments on the consultation paper.

Main Views and Key Points

General Comments

• The ZKA supports the approach of limiting the scope of the guidelines to principles rather than detailed rules.
• They emphasize the importance of discretion for national supervisory authorities to reflect national idiosyncrasies and avoid excessive regulatory burden, especially for smaller banks.
• The principle of proportionality should apply to stress testing methods, and the framework should be flexible to accommodate different bank sizes and complexities.
• Stress testing should not automatically result in capital surcharges. Institutions should have the discretion to decide which capital components to use in response to stress test results.
• The ZKA stresses that stress testing is an internal instrument and should not be used as a default mechanism for increasing regulatory capital requirements.
• They advocate for a broader, more flexible approach to credit risk stress testing that accounts for portfolio-specific aspects.

Specific Comments on Sections

• No. 2: Should clarify that stress testing does not automatically lead to capital surcharges.
• No. 15–17: The distinction between sensitivity analysis and scenario tests is considered redundant and should be deleted.
• No. 16: The reference to "Black Monday" is problematic as it may imply that stress tests must be based on historical events. The ZKA suggests that stress testing should be based on current economic conditions.
• No. 18: The requirement to compare stress testing results with earnings is questioned. The ZKA suggests that the language should be adjusted to allow institutions to decide which capital components to include.
• No. 21: The preference for a combination of scenario tests and sensitivity analyses should be left to the discretion of the institution.
• No. 27: The requirement to stress all material sensitivities is considered impractical, as sensitivities are not constant. The ZKA suggests deleting the last sentence.
• No. 29: The reference to back testing is considered outside the scope of the guidelines and should be removed.
• No. 30–31: The language should be adjusted to avoid implying that capital buffers are mandatory. The ZKA suggests that the term "should" be replaced with "could" and that the word "may" in No. 31 should be deleted.
• No. 33–34: Legal entity stress testing is considered burdensome and should be replaced with a more flexible approach, such as the one proposed by the FSA.
• No. 35: The term "holding period" should be replaced with "risk defeasance period" to better reflect the time needed to mitigate risks.
• No. 36–47: The documentation requirements should be simplified and focused on key aspects such as scope, assumptions, and remedial measures. The ZKA suggests that documentation should not be overly detailed and that approval can be delegated.
• No. 48: The mandatory annual assessment should only cover scenarios and parameters, not the entire stress testing process.
• No. 52: The requirement to consider future business plans in stress testing is questioned, as it is part of the budget planning process and not stress testing.
• No. 56: The requirement to consider tail events beyond the 10-day VAR 99% confidence level is seen as conflicting with earlier guidance on "exceptional but plausible" events. The ZKA suggests using the term "exceptional but plausible" and deleting the fourth bullet point.
• No. 60: The requirement for specific LGD calibration for LE reporting is considered burdensome and unnecessary. The ZKA suggests using collateral haircuts instead.
• No. 66: This section is deemed unnecessary and should be deleted.
• No. 70: The requirement to provide capital backing for credit exposure from stress tests is rejected, as other measures may suffice.
• No. 71: The language suggesting a difference between the stress tests in Annex VII and those in the main text is questioned. The ZKA suggests aligning the terminology to avoid confusion.
• No. 77: The statement that stress testing results may lead to additional capital requirements is considered misleading. The ZKA suggests deleting the word "necessarily" and the examples.
• No. 87: The example linking credit risk stress tests to liquidity risk is rejected, as it lacks sufficient data and methodological basis.
• No. 88–89: The ZKA questions the separation of liquidity risks from other risk types and suggests that the examples should be provided in the main text, not just in the annex.

Recommendations

• Stress testing should remain an internal tool and not be used to automatically increase regulatory capital requirements.
• The principle of proportionality should guide the application of stress testing methods, with flexibility for institutions.
• The use of portfolio models should not be mandatory, especially for smaller banks.
• Documentation requirements should be simplified and focused on essential elements.
• The language of the guidelines should be adjusted to avoid confusion and unnecessary burdens on institutions.
• The scope of stress testing should be limited to areas where quantification is feasible, with clear guidance on when it is not.
• The ZKA supports the use of illustrative examples in the annex but emphasizes that they should not be mandatory.

Conclusion

The ZKA's comments reflect a strong preference for flexibility, proportionality, and discretion in the implementation of stress testing guidelines. They advocate for a balanced approach that supports effective risk management without imposing undue regulatory burdens, particularly on smaller institutions. The ZKA also highlights the need for clarity and consistency in the language used throughout the consultation paper.