Morning Equity Briefing
Banks
CEBS publishes revised stress-testing guidelines
Emer Lang
FACTS: The Committee of European Banking Supervisors (CEBS) has published revised guidelines on stress-testing, which take into account the results of an earlier public consultation (from December 2009 to March 2010) and replace its previous guidelines, which date from 2006. Since then, there have been a number of developments in stress-testing. In particular, CEBS cites the financial crisis of 2008-2009 as highlighting significant lessons in relation to stress-testing practices. The new guidelines follow the publication of stress-testing results for 91 European institutions in July, a process which attracted some criticism for not being tough enough.
ANALYSIS: According to CEBS, the revised guidelines draw on the experience that supervisors have obtained by reviewing institutions’ stress tests in recent years. They are designed to be as practical as possible and aim to identify the relevant 'building blocks' in an effective stress-testing programme, ranging from simple sensitivity analysis on single portfolios to complex macroeconomic scenario stress-testing on a firm-wide basis. Stress-testing should be based on 'exceptional but plausible' events. The methodologies recommended by CEBS include traditional sensitivity and scenario analysis, but it also introduces 'reverse stress-testing'. This consists of identifying a significant negative outcome and then tracking the causes and consequences that could lead to such an outcome.
DAVY VIEW: As CEBS points out, the financial crisis of 2008-2009 highlighted significant lessons in relation to stress-testing. In particular, CEBS suggests that in general, where they were used, scenarios were not sufficiently severe 'nor was there appropriate consideration given to the potential crystallisation of confluences of events'. These new detailed guidelines aim to help institutions and supervisors to achieve more 'robust, methodologically sound outputs' that are effective in identifying risks and their potential mitigants during stressed conditions. CEBS expects its members to apply the guidelines by December 31st 2010, meaning they should be incorporated into national supervisory guidelines and implemented in supervisory practises. It plans to conduct an implementation study one year after the implementation date, to ensure harmonisation across member states.