In case you forgot that other crisis…
The European Banking Authority has just published parameters for the upcoming European bank stress tests. A first glance has them about as meek as expected.
Major points and assumptions below:
- The exercise will be carried out using banks’ year-end 2010 figures.
- No workout of defaulted assets is assumed in the exercise, therefore banks’ portfolios will stay constant. Apparently some banks don’t like this aspect. It does mean that their balance sheets will shrink due to impairments.
- The banks themselves are expected to estimate the effect of key macro-economic variables of the scenarios – including GDP, unemployment, interest rates and property prices – on their balance sheet. Those scenarios are here.
- Funding needs of the banks are considered stable during the time horizon of the exercise and no change in funding structure is permitted in the exercise.
- In the baseline scenario all direct and indirect sovereign exposures in the trading book will be subject to a general “interest rate” stress, representing an upward movement in the swap curve. This general interest rate stress will affect non-sovereign exposures the same way as sovereign exposures.
- And under the adverse scenario, direct eurozone sovereign exposures in banks’ trading books will be subject to further valuation shock based on specific sovereign rate shocks. The shock isn’t much different to what’s already been leaked to the media though — European stock prices are assumed to be 15 per cent lower, the US dollar to be 11 per cent weaker against major currencies, short-term interest rates to be higher by 125 basis points and long-term eurozone sovereign bond yields to be higher on average 75 basis points.
- Banks will also be expected to disclose their exposures to sovereigns, broken down by accounting portfolios (AFS, HTM, HFT), maturities and countries.
- Bizarrely, there’s no definition of what qualifies as capital (a criticism of the last stress test) yet. Apparently, the “exact definition of capital and the threshold set up for the purposes of the exercise” will be provided at a later date.
The full 51-page methodology is available here.
The tests will be carried out starting around now, with results published in June.