Financial Services Advisory

Insights into the 2020 EU-wide Stress Test

Dwayne Price Dwayne Price

In November 2019, the EBA published the finalised methodology and draft templates for the 2020 EU-wide stress test

The methodology covers all risk categories and builds upon the methodology provided for the 2018 exercise. It clearly outlines how banks should approach and complete the EU-wide stress test exercise.

Similar to the 2018 exercise, the 2020 EU-wide stress test is a bottom-up exercise with constraints, including a static balance sheet assumption. Once again, the exercise does not include a pass / fail element, however, the results do serve as an input into the Supervisory Review and Evaluation Process (SREP). 

The 2020 EU-wide stress test incorporates a sample of 50 banks, covering broadly 70% of the banking sector in the euro area. Preliminarily, UK banks were excluded under the assumption that the United Kingdom would leave the EU on October 31, 2019. However, since it now appears that the Brexit will be delayed until 2020, UK banks are now included in the sample.

"UK banks will be included in the sample since the UK will be subject to EU law when the 2020 EU-wide stress test commences. If the UK leaves the EU and ceases to be subject to EU law prior to the conclusion of the stress test then UK banks will cease to be part of the sample"

Significant notes regarding the 2020 EU-wide stress test

The 2018 exercise included an array of changes in methodology and reporting in order to comply with the introduction of IFRS 9 accounting standards.

The 2020 EU-wide stress test also includes updates to account for regulatory changes

which are due to be introduced during the horizon of the stress test. Some of the key changes are outlined below:

  • Forecasted parameters based on the new definition of default as outlined in article 178 of the CRR if implemented as of 31 December 2019.
  • An impact assessment of this new definition is to be included in the explanatory note.
  • Banks are required to report the LTV ratio for selected real estate related exposure classes.
  • Banks are required to deduct the expected impact of applying minimum loss coverages for NPEs from CET1 capital[1].
  • New securitisation framework.
  • Standardised average point of maturity for asset and liabilities with regard to net interest income.
  • Treatment of sight deposits.
  • Revised definition of net trading income.

2020 EU stress testv3.png

The schedule for the 2020 exercise is closer aligned to 2016 than 2018. The condensed timeline of events for the 2020 EU-wide stress test in comparison to 2018 will increase the pressure for banks to meet submission deadlines. However, to accommodate banks the EBA has explicitly stated that they will not have to include changes or corrections through the FAQ process if published too close to the release date.

Indications for future EU-wide stress tests

Despite the overall consistency in methodology in recent exercises, the EBA have indicated that there are also shortcomings with the approach. In particular, the EBA highlighted the following possible changes with regard to 2022 and beyond:

  • Top-down approach
  • Unconstrained internal bottom-up approach
  • Dynamic balance sheet

The EBA will weight up the cost and benefits of introducing such fundamental changes and if necessary will delay them beyond 2022[2]

What can Grant Thornton offer?

Grant Thornton Ireland has significant experience gained from supporting many clients in previous regulatory stress tests, and in preparatory engagements for the EU-wide stress test exercise; and through a suite of tools including a template validation checker, credit risk, IFRS 9 application (which requires a greater demand on forecasting methodologies and data quality), and a top-down fast analysis tool.

Our highly qualified Quantitative Risk team provides support to financial institutions across the full spectrum of risk measurement and modelling strategies, including the development, deployment and validation of key models and risk measurement methodologies in regulatory capital, stress testing and IRB, IFRS 9 and bank risk modelling. With regard to stress testing, the Quantitative Risk has successfully delivered the following:

  • Developed benchmark models to challenge existing models and validate their suitability for purpose.
  • Automated tool to populate and validate results template submission.
  • Demonstrated expertise in engagement with the regulator regarding the submission results.
  • Significant experience in developing IFRS9 model across a range of asset classes and translating these risk parameters into an effect stress-testing engine.

Our industry-leading Prudential Risk team understands that regulation continues to drive the strategic agenda for banks. They specialise in assisting clients across the financial services sector in navigating through the maze of regulation and supporting clients to identify regulatory obligations and work towards full compliance.

Our Financial Services Consulting team can provide in bank-wide programs to help lead to a successful and efficient delivery of the stress test. Our people hold internationally recognised project management qualifications, and have gained considerable experiences in assisting clients to deliver significant change programmes arising from the regulatory agenda

[1] For further information, see Jose Manuel Campa’s speech “The EU-wide stress test: can the glass be more than half full?” 

[1] For further information, see Regulation (EU) No 2019/630

Subscribe button.jpg