Stress test of the EU-wide and UK banking systems: Recent updates

EU-wide stress testing 

The EU-wide stress test for banks is used to assess their resilience to adverse economic and market developments and contributes to the assessment of systemic risk in the EU financial system. Earlier in 2021, the Board of Supervisors of the European Banking Authority (EBA) decided to carry out its next EU-wide stress test in 2023. 
 
The draft methodology, templates and template guidance were published by EBA for further informal discussion with the industry. As a new feature, the projections on net fee and commission income (NFCI) will be based on a top-down model. This is a first step of revising the EU-wide stress test framework towards a hybrid (bottom-up and top-down 1) approach. 

Although, some aspects of the methodology have been improved based on the lessons from the 2021 exercise, the received input from banks also will be taken into account when finalizing both documents. 

1 The guidelines’ definition of ‘Bottom-up stress test’ sets out that this type of stress test is carried out by the institution. A ‘Top-down stress test’ is carried out by the competent authority or the macro prudential authority.

Annual cyclical scenario (ACS) stress test of the UK banking system 

The stress testing of banking system will also take place across jurisdiction of United Kingdom (UK). Namely, on  September 26, 2022, the Bank of England has published the scenario that it will be using for the 2022 annual cyclical scenario (ACS) stress test of the UK banking system to assess how banks can cope with severe economic scenarios.  

 
It is important to note that the stress test is not a forecast of macroeconomic and financial conditions in the UK or abroad based on the current geopolitical picture and government view. The results are used by the Financial Policy Committee (FPC) and Prudential Regulation Committee (PRC) to assess the resilience of the UK banking system, ensuring banks have enough capital to withstand extreme shocks and support the UK economy. 
 

While previous stress tests have incorporated the impact of higher interest rates in the UK, this ACS will for the first time test UK banks’ resilience to higher global interest rates, confronted with a series of global cost shocks and persistent global inflation. The paths for interest rates are simply assumptions for the purposes of the stress test. For example, in the current scenario, UK Bank Rate is assumed to rise rapidly to 6% in early 2023 before later being reduced gradually to under 3.5%. 
 
See other assumed rates included as selected key elements in the scenario here. 

The 2022 ACS will cover a five-year horizon, with a start point of end-June 2022. 

Banks will be evaluated on an International Financial Reporting Standard 9 (IFRS 9) transitional basis and the associated hurdle rate adjustments will be further applied. Nevertheless, the FPC and PRC do not exclude the potential for large capital drawdowns at the beginning of a real stress under IFRS 9.  
 
Barclays, HSBC, Lloyds Banking Group, Nationwide, NatWest Group, Santander UK, Standard Chartered and Virgin Money UK – are the eight participating banks and building societies, as together they account for around 75% of lending to the UK real economy. This is the first time when such ring-fenced subgroups of Barclays, HSBC, Lloyds Banking Group and NatWest Group pioneered as assessed entities on a standalone basis. 

The results of the test will be published in summer 2023 and, along with other relevant information, will be used to help inform banks’ capital buffers - both the UK countercyclical capital buffer (CCyB) rate and Prudential Regulation Authority (PRA) buffers. 

The related documents, like scenario, data templates, manual and dictionary for the annual concurrent stress test 2022, are available here.