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EBA-IMF Colloquium Summary: New Frontiers on Stress Testing

Core Content

Andrea Enria, Chairperson of the European Banking Authority (EBA), delivered introductory remarks at the EBA-IMF Colloquium on 1 March 2017, focusing on the evolution and future of stress testing in the European Union. The event was held in London and aimed to explore new frontiers in stress testing, as well as the technical, policy, and logistical challenges associated with such exercises.

Main Points

• History of EBA Stress Testing: The EBA has conducted three EU-wide stress tests since 2011, with the last one in 2016, and a recapitalisation exercise in 2011/2012. The 2018 stress test is in the preparatory phase.
• Impact of Stress Testing: These exercises have significantly improved the capital position of European banks, increasing their CET1 ratios from 9.2% in December 2011 to 14.1% in September 2016. Common equity has also increased by €180bn between 2013 and 2015.
• Transparency and Market Discipline: Detailed disclosure of stress test results has reinforced market discipline and restored confidence in the financial sector. Transparency is essential for competitive markets and helps investors assess risk and value.
• Communication Challenges: Stress tests are hypothetical and based on specific assumptions. They provide a forward-looking view but do not cover all potential risks. Clear communication is necessary to manage expectations and ensure that market participants understand the limitations of the exercise.
• Methodological Evolution: The EBA has moved from a crisis-focused stress test to a supervisory stress test, which assesses bank resilience and capital planning. This shift has reduced reliance on a public backstop and emphasized a coordinated supervisory approach.
• Methodological Changes for 2018: The 2018 stress test will incorporate the new IFRS 9 accounting treatment for impaired assets, which will significantly affect credit risk and provisioning levels. This is a major technical challenge for banks.
• Need for a Common Framework: There is a need for a common understanding and an integrated framework for public intervention in the event of clear recapitalisation needs identified through stress testing.
• Time Constraints: The EBA is currently updating the methodology for the 2018 exercise and has limited time to finalize it and engage with the industry.

Key Information

• Capital Improvements: European banks have improved their capital ratios by over 400 basis points since 2011.
• Sovereign Debt Crisis and Brexit Impact: The EBA has faced challenges in the past due to events like the sovereign debt crisis in 2011 and the UK referendum in 2016, which cast doubt on macroeconomic scenarios.
• Stress Test Purpose: Stress tests are a diagnostic tool for policy makers, not a definitive answer to all questions. They are part of a broader supervisory toolkit.
• 2018 Stress Test Timeline: The 2018 exercise is expected to be launched at the beginning of 2018, with results published in mid-year.
• Quotation from Charles Goodhart: Enria concluded with a quote from Charles Goodhart, emphasizing the importance of stress testing in identifying fragile banks and preventing potential failures.

Conclusion

The EBA-IMF Colloquium aims to address the evolving landscape of stress testing in the EU. While the EBA has made significant strides in improving the capital and resilience of European banks, the process remains dynamic and requires continuous refinement. The 2018 stress test will be a critical step in this journey, incorporating new accounting standards and fostering a more integrated supervisory approach. Enria expressed his eagerness to hear the participants' views and insights on these topics.