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2018 EU-wide Stress Test Summary

Core Content

The 2018 EU-wide stress test is a regulatory exercise conducted by the European Banking Authority (EBA) and the European Central Bank (ECB) to evaluate the resilience of EU banks to adverse economic shocks. It is part of the supervisory toolkit used by Competent Authorities (CAs) to assess banks' solvency, identify uncertainties, and support supervisory decision-making. The results also aim to strengthen market discipline through the publication of detailed, bank-by-bank data.

Main Banks Involved

• The stress test is conducted at the group level.
• It includes 48 banks across the EU, with 33 from the euro area and the remaining from Denmark, Hungary, Norway, Poland, Sweden, and the UK.
• These banks represent approximately 70% of the total assets of EU banks.

Exclusions and Reasons

• Subsidiaries of parent banks already in the sample are excluded.
• Smaller banks in the euro area are not included but are still subject to ECB-Banking Supervision stress tests.
• Greek banks had to publish results earlier in May 2018 to align with the European Stability Mechanism (ESM) Programme timeline.

Role of the EBA

• The EBA is responsible for:
  • Developing a common methodology.
  • Coordinating the exercise.
  • Providing minimum guidance and EU-wide descriptive statistics for consistency checks.
  • Acting as a data hub for the dissemination of results.
  • Facilitating communication between home and host authorities via colleges of supervisors.

Roles of Other Entities

• The ESRB and ECB collaborate with CAs, the EBA, and national central banks to design the adverse macroeconomic scenario.
• The ECB provides the macroeconomic baseline scenario.
• CAs (including ECB-Banking Supervision) are responsible for:
  • Ensuring quality assurance of the results.
  • Assessing the reliability and robustness of banks' assumptions, data, and models.
  • Taking supervisory actions based on the results.

Methodology and Scenarios

Key Methodological Features

• The stress test is a solvency stress test using a constrained bottom-up approach.
• Banks apply the common EBA methodology with their own models.
• Static balance sheet assumption is used, meaning balance sheets are frozen at the reference date.
• IFRS 9 impairment model is implemented, which is forward-looking and based on expected credit losses (ECL).
• A single market risk scenario is used, with specific treatment for Level 2 and Level 3 financial instruments.

Risks Covered

• Credit risk (including securitisations).
• Market risk, counterparty credit risk (CCR), and credit valuation adjustment (CVA).
• Operational risk, including conduct risk.
• Sovereign risk is included in both credit and market risk, depending on the accounting treatment.
• Net interest income and profit & loss items not covered by other risk types are also projected.

Sovereign Risk Treatment

• Sovereign exposures measured at amortised cost use ECB-developed PD and LGD parameters.
• Sovereign exposures measured at fair value through profit or loss or other comprehensive income are subject to full revaluation under the adverse market scenario.

Adverse Scenario Key Features

• Cumulative GDP fall over 3 years: 2.7%.
• Unemployment rate in 2020: 9.7%.
• Cumulative inflation over 3 years: 1.7%.
• Residential real estate price fall: 19.1%.
• Commercial real estate price fall: 20%.

Severity of the Scenario

• The 2018 adverse scenario is more severe than any previous EU-wide stress test.
• It reflects a deviation of EU GDP by 8.3% in 2020 from the baseline.
• Unemployment increases by 3.3 percentage points.
• Inflation is 1.9% below baseline.
• Residential and commercial real estate prices fall by 27.7% and 27.1% respectively.
• It is comparable to the severely adverse scenario used by the Federal Reserve Board in the Comprehensive Capital Analysis and Review (CCAR).

Limitations of the Scenario

• The adverse scenario is hypothetical and does not cover all possible risks.
• It serves as an analytical tool to assess the impact of an economic downturn.
• Additional idiosyncratic risks should be considered in the SREP (Supervisory Review and Evaluation Process).

Brexit Consideration

• The adverse scenario includes a range of macroeconomic risks related to Brexit.
• It reflects the average of possible outcomes from the UK's relationship with the EU.
• Banks and supervisors should assess Brexit-specific risks as part of contingency planning and the SREP.

Recent Market Developments

• The adverse scenario reflects the four systemic risks identified by the ESRB General Board:
  1. Abrupt and sizeable repricing of risk premia.
  2. Weak bank profitability and low nominal growth.
  3. Debt sustainability concerns and political fragmentation.
  4. Liquidity risks in the non-bank financial sector.
• These risks remain relevant in light of recent market developments.

Results and Comparisons

• The 2018 results show a higher CET1 ratio depletion compared to the 2016 exercise.
• The impact of credit risk is more significant in 2018.
• IFRS 9 transitional arrangements allow for a lower impact on CET1 ratios for banks using them.
• Both transitional and fully loaded CET1 ratios are provided for comparability and supervisory purposes.
• A list of banks using transitional arrangements is included in the summary report.

Disclosure and Transparency

• The EBA publishes detailed, bank-by-bank data including:
  • Actual data as of the end of 2017.
  • Projected data under the stress scenarios.
• Sovereign exposures are not disclosed by country in the 2018 exercise due to methodological changes.
• The 2018 EU-wide transparency exercise will include sovereign exposures and will be published annually in December.
• The EBA also provides interactive tools and data files for further analysis.
• The annual EBA Risk Assessment Report is published alongside the transparency data.

Next Steps

• The stress test results are used to:
  • Inform the SREP process.
  • Support Pillar 2 guidance.
  • Assist CAs in assessing banks' ability to meet prudential requirements under stress.
  • Guide discussions with banks to establish management actions for capital planning and ensuring capital adequacy under stress conditions.