A review of stress test methodology

Abstract

After a general introduction of the concept of bank stress testing, and the possible applications by different stakeholders, the paper provides an overview of the European Banking Authority (EBA) EU-wide stress test. It explains its main features, the scope of risks assessed, the different actors involved and the benefits of the exercise. It also explains the role of the EBA in the different stages of the exercise, the evolution of the exercise and its purpose as a tool to assess potential vulnerabilities of banks and their resilience to adverse market developments, provide transparency on banks’ exposures and as a supervisory tool. The paper then focuses on the 2018 EBA stress test and explains the main changes applied to the EBA stress test methodology in 2018 for the different risks. The paper pays special attention to the changes linked to the implementation of the new International Financial Reporting Standard (IFRS 9). It elaborates on the effects of IFRS 9 and the implications of the IFRS 9 rules for the credit risk stress test in terms of lifetime expected credit losses, the definition of stages and the movement of exposures between stages.