Builds on the 2014 stress test approach but extends it with the following:
Include global as well as domestic risks
Traded risk scenario
Leverage ratio threshold as part of a hurdle rate framework
Context to stress against in 2015
Euro zone area is nearly 50% of UK exports
Moderation of China growth in accordance with the IMF world Economic Outlook (WEO)
large current account deficits in a number of emerging market economies exposed to rapid capital outflow
market liquidity may not have reached a new equilibrium
2015 concentrates on further deterioration of global nominal growth
Qualitative difference between 2014 and 2015 stress test
2015 assesses resilience to a difference set of risk relative to 2014
Principally focused on the resilience to severe financial market shocks (rather than houeshold market shock)
Previously UK banking system assessed against a single global state of the world.
Focuses on exploring vulnerabilities stemming from the rest of the world rather than domestic risk. 2014 concentrated on stressing the UK housing market
2015 explores deflationary macroeconomic environment associated to reduction in bank rate and extraordinary monetary policies. 2014 included inflation shock in the UK only and associated monetary policy
2015 concentrates on UK domestic corporate exposures which were identified in 2014 as a key area of focus. 2014 was more on UK household sector.
Hit to economic activity is highest ok Euro zone and emerging markets
Incorporates a traded risk scenario designed by the bank of England. 2014 applied the EBA methodology.
Traded risk scenarios designed to be consistent in both severity and geographic impact with the macro-economic stress scenario
2015 test scenarios test bank’s ability to withstand default of a number of counterparties
Risk capital threshold i.e. hurdle rate set at 4.5% of RWA to be met with common equity Tier 1 (CET1)
CET1 set at 3% of the leverage exposure measure to be met with Tiers 1 capital where relevant additional Tier 1 instruments would be permitted to comprise 25% of this requirement.
Banks are not assumed to reduce the flow of lending as a means of preserving capital through changes in prices relative to their funding costs or through non-price terms. Has to reduce organically. Guidance has been provided to banks ion their balance sheet modelling.
Scenario broadly speaking
World GDP is a useful metric to gauge severity of shocks to activity
Key objective of stress testing is to explore events that have not happened in recent history but may nevertheless be judged possible macroeconomic outcomes.
Inspect UK GDP history from 1871 on !
For other countries than UK, decline in activity is within historical experience. Nevertheless comparison to these historical outturns is a useful gauge of the scenario’s severity
Downturn in Euro area is more prolonged relative to other advanced economies
Introduction of coordinated shocks across countries
IMG found that factors such as heightened uncertainty and wake up calls that changed investor’s perceptions in addition to financial interlinkages were important in explaining comovements during the 2008 crisis
Two particularly important variables that affect overall severity are unemployment and property prices
Residential and commercial real estate prices often comove during crises
Downturn in housing markets are highly synchronised across coutnries (Claessens, Kose and Terrones – 2011)
Key factor scenarios (non-exhaustive, only key elements mentioned)
Longer time horizon than 2014 stress test
reduction in commodities prices
The renminbi is allowed to depreciate 10ç% against US dollar by 2015 Q4
SHIBOR interest rate initially rise sharply and peak in Late 2015
Chinese property market at 365% below their level at end 2014 through 2016
Falls in commercial property prices more pronounced
Sharp falls in real estate investment and industries associated with construction
Output growth slows due to combination of international spillovers and domestic amplifications
Domestic consumption and investment fall.
real GDB goes down to -2.1% in 2016 Q1
Aggregate GDP growth turns positive in 2017
Inflation turns positive in 2018 but subdued until end of scenario
Downturn in economic activities especially those with ties with China
Investors demand higher risk premia on foreign borrowing triggering sharp slowdown in capital inflows
Suffers spillovers from the global slowdown
Less affected than some other regions as considered a safe-haven for capital
output growth turns negative in 2015 Q3 as export demand falls sharply and spillovers from confidence effects
Inflation turns negative for the first 7 quarters, Largest fall in the price level for over 80 year