Frequently asked questions on 2021 stress test
Frankfurt, 30 July 2021
What is the 2021 EU-wide stress test about? What’s its objective?
The EU-wide stress test uses 2020 end-of-year data to analyse how a bank’s capital position develops over a period of three years until 2023, under both a baseline and an adverse scenario. The exercise provides supervisors, banks and other market participants with a common analytical framework to consistently compare and assess the resilience of EU banks to country-specific economic shocks. Within the SSM, the stress test results for all significant institutions will also be used to assess the Pillar 2 capital needs of individual banks in the context of the Supervisory Review and Evaluation Process (SREP).
The qualitative outcomes will be included within the scope of risk governance in the SREP, thereby influencing the determination process for the Pillar 2 requirements (P2R). The quantitative results will be used as a key input for setting the Pillar 2 Guidance (P2G).
The exercise is designed to strengthen market discipline through the disclosure of consistent and granular information on a bank-by-bank level, illustrating how balance sheets are affected by common shocks. It should be noted that supervisory stress test exercises are not a substitute for banks’ internal stress test exercises based on scenarios tailor-made for their respective circumstances.
Why is the ECB publishing some results for SSM Banks this year?
The purpose of the publication is to further increase transparency. At the same time, maintaining the principle of proportionality was important: banks that participate in the SSM stress test are smaller than the banks that participate in the EU-wide exercise, and may not be able to devote the same level of resources to the stress test process. Our publication approach takes this into account by concentrating on key indicators and using ranges in some cases, thus avoiding the additional need for a larger number of indicators. These indicators focus on bank-specific information on 1) high-level individual results, 2) starting point data, and 3) scenario sensitivities.
What will the ECB do with the banks that have a (severe) shortfall in the adverse scenario?
The 2021 stress test is – like those in previous years – not a pass-or-fail exercise, and so there is no “shortfall” in the usual sense. Instead, the exercise provides key inputs to the Supervisory Review and Evaluation process (SREP) for each institution. In practice that means that for those institutions with a (severe) capital depletion in the adverse scenario, the stress test result will be used as a starting point for setting the P2G (as foreseen in the EBA Guidelines on SREP and supervisory stress testing).
In line with this approach, banks with (severe) capital depletion in the adverse scenario should generally expect a higher P2G compared to banks with better results. At the same time, there is no one-to-one mapping between stress test depletion and P2G.
Where the severe capital depletion highlights particular risks in certain areas of business, the joint supervisory teams will use this information to follow up with targeted supervisory initiatives and, where appropriate, measures to ensure the proper management of those risks.
Why aren’t you showing exact CET1 ratio numbers for those banks falling below 8% in the SSM’s publication, and how should observers interpret the data?
By design, stress test results are only one element in the ECB’s supervisory toolkit. They assess the resilience of a bank in a hypothetical scenario using a very specific set of methodological assumptions. They only provide an indication of how a bank would fare under possible adverse developments. On this basis, while results of the stress test provide an indication of where a bank stands, in particular when compared to its competitors, results have to be assessed in the context of this structural design. For the 2021 publication we have increased the transparency of results of the SSM stress test over that of 2018, for which we disclosed only high-level results on an aggregate level.
At the same time, maintaining the principle of proportionality was also a core objective: banks that participate in the SSM stress test are generally much smaller than the larger banks that participate in the EU-wide exercise, and may not be able to devote the same level of resources to the stress test process.
Our publication approach takes this into account by concentrating on very few relevant indicators, thus avoiding the much more burdensome quality assurance process needed to ensure the consistency and additional accuracy of a very large number of indicators.
With this in mind, it is clear that results in this range vary and also include banks that would need to take action to maintain compliance with their minimum capital requirements. The respective overall assessment is performed by our supervisory teams and duly incorporates stress test results into the SREP.
What fallout has the ECB noticed from the coronavirus crisis? Do you see any clear patterns?
The adverse scenario assumes a prolonged coronavirus impact in a lower-for-longer interest rate environment. The reassessment of market participants’ expectations amid declining corporate earnings leads to an abrupt and sizeable adjustment of financial asset valuations. The system-wide CET1 ratio depletion stands at -5.2 percentage points on a fully loaded basis in the adverse scenario. The main drivers for the depletion in the adverse scenario are loan losses, the significant stress on net interest income, trading income, and net fees and commission income as well as the impact from the equity and credit spread shocks on positions measured at fair value.
Public guarantee schemes and EBA-compliant coronavirus-related moratoria are explicitly addressed in the stress test methodology. Loans under a public guarantee scheme are assumed to be replaced with the guarantee, regardless of whether the particular scheme is expected to still be in place, while banks have to project loan losses assuming no beneficial impact of EBA-compliant coronavirus-related moratoria.
Moreover, it has been observed that the industry sectors which emerged as vulnerable in 2020 also show higher and more volatile impairment rates under the adverse scenario. For example, wholesale and retail trade and repair of motor vehicles and motorcycles, rental and leasing activities, and accommodation reported the highest median cumulative impairment rates.
Finally, despite banks’ successes in cutting costs and implementing targeted NPE-reduction strategies since the 2018 stress test, a substantially more severe macroeconomic adverse scenario than the one used in that exercise overcompensates for the effect of these improvements and leads to a higher system-wide CET1 ratio depletion than in 2018 (5.2 percentage points vs. 4.0 percentage points).
How are stress test results integrated into the SREP?
The results feed into the SREP in both a qualitative and quantitative manner.
- Qualitative outcome: The JSTs consider different aspects when assessing the internal governance and risk management of a bank in the SREP, which eventually influences the determination of the Pillar 2 requirements. These aspects include, for instance, the timeliness and accuracy of data, as well as the quality of information received. Likewise, quantitative metrics generated directly from IT-based data aim to provide the JSTs with measurable criteria to assess the banks’ performance by applying a scoring based on four levels. Both the banks’ ability to cope with the data requirements and their responsiveness throughout the stress test exercise are measured. In addition, JSTs carry out a qualitative assessment of the banks’ performance during the stress test quality assurance cycles.
- Quantitative outcome: The methodology for setting P2G follows a two-step approach. In step 1 the bank is placed in a bucket according to the maximum CET1 depletion during the supervisory stress test exercise. The buckets are designed on the basis of recent supervisory experience, SSM risk tolerance and the severity of the stress test exercise. In step 2 the JSTs exercise their expert judgement to adjust the P2G to the idiosyncratic profile of each institution. The JSTs can adjust within the ranges of the corresponding bucket and, exceptionally, beyond the range of the relevant bucket.