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EBA releases 2016 stress test methodology

The European Banking Authority has released the methodology that will be used to assess solvency and the scenario it will use for the 'stress test' of banks that begins this week. 26 Feb 2016

Stress tests are designed to measure banks' financial resistance to adverse conditions. In the latest round of checks, 53 banks will be assessed, 39 of which fall under the jurisdiction of the Single Supervisory Mechanism, the EBA said.

The methodology will look at all main risk types including credit risk and securitisation, market risk, sovereign risk, funding risk and operational and conduct risks. The results will be studied by the supervisors of each country's competent authority, the EBA said.

Unlike in previous years there will be no pass or fail to the test. Instead, the competent authority will discuss the results with each individual bank.

The "adverse scenario" that the banks will be tested against has been designed by the European Systemic Risk Board. It takes into account the four biggest current risks to the stability of the European banking sector, the EBA said: low profitability, market illiquidity, a rise in funding costs for banks, and shadow banking.

The scenario looks at a 3.1% change in the EU's gross domestic product from its baseline level in 2016, 6.3% in 2017 and 7.1% in 2018. The scenario also includes a shock in residential and commercial real estate prices, as well as to foreign exchange rates in Central and Eastern Europe.

Financial services expert Michael Ruck of Pinsent Masons, the law firm behind Out-Law.com said: "It is an interesting decision by the EBA to conduct a stress test which cannot be failed.  While the outcome will be discussed with each individual bank, it is likely criticism will be levelled at the EBA around its lack of transparency and whether the stress test on this occasion is actually a test at all."

The EBA expects to publish the results of the stress test in the third quarter of this year, it said.

The EBA did not run a stress test in 2015, but instead ran a 'transparency exercise' to gather data on banks' balance sheets and portfolios.