EBA launches tough new stress tests including potential Brexit effect.

The European Banking Authority (EBA) has launched its toughest stress test yet to ensure banks across the EU can withstand severe economic shocks, including from the impact of Brexit. The test includes the most severe adverse scenario for economic growth of any so far, with a potential hit of 8.3 per cent to the EU’s GDP by 2020. The EBA said: “the adverse scenario encompasses a wide range of macroeconomic risks that could be associated with Brexit.”

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 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:

1.     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;

2.     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;

3.     Public and private debt sustainability concerns amid potential repricing of risk premia and increased political uncertainty;

4.     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.

 

Dr. Ray NultyComment