EBA launches 2018 EU-wide stress test exercise

The European Banking Authority (EBA) has launched its 2018 EU-wide stress test and released the macroeconomic scenarios. The adverse scenario implies a deviation of EU GDP from its baseline level by 8.3% in 2020, resulting in the most severe scenario to date. The EBA expects to publish the results of the exercise by 2 November 2018.

Key features of the exercise

The stress test is designed to provide supervisors, banks and other market participants with a common analytical framework to consistently compare and assess the resilience of EU banks to economic shocks. For the first time, it incorporates IFRS 9 accounting standards.  No pass-fail threshold has been included as the results of the exercise are designed to serve as an input to the Supervisory Review and Evaluation Process (SREP).
The EBA’s 2018 stress test methodology was published in November 2017 and is to be applied to the scenarios released today.
The baseline scenario is in line with the December forecast  published by the European Central Bank (ECB), while the adverse scenario assumes the materialisation of four systemic risks, which are currently deemed as representing the most material threats to the stability of the EU banking sector:
  • Abrupt and sizeable repricing of risk premia in global financial markets,  which would spill over to the European countries and lead to a tightening of financial conditions;
  • Adverse feedback loop between weak bank profitability and low nominal growth resulting from the decline in economic activity in the European Union.This will affect, in particular, banks in those countries facing  structural challenges in their banking sector;
  • Public and private debt sustainability concerns amid potential repricing of risk premia and increased political uncertainty;
  • Liquidity risks in the non-bank financial sector with potential spill-overs to the broader financial system.
The adverse scenario is designed to ensure an adequate level of severity across all EU countries. The implied EU real GDP growth rates under the adverse scenario amount to -1.2%, -2.2% and +0.7%, in 2018, 2019 and 2020 respectively. Overall, the scenario implies a deviation of EU GDP from its baseline level by 8.3% in 2020, resulting in the most severe scenario in terms of GDP deviation from baseline levels compared with the previous EBA exercises.
Detailed information about the scenario can be found in the note produced by the European Systemic Risk Board (ESRB).

Process

The adverse macroeconomic scenarios have been developed by the ESRB and the ECB in close cooperation with the EBA, competent authorities, and national central banks.
The EBA, which is responsible for coordinating the whole exercise, developed a common methodology and will act as a data hub for the final dissemination of the results, in line with its commitment to enhancing the transparency of the EU banking sector. Competent authorities will assure the quality of the results and decide on any necessary supervisory reaction measure as part of the SREP process.