The Financial Stability Aspects of the EU-wide Stress Test

Micro-prudential stress tests, such as the EU-wide stress test of the European Banking Authority, relate to macro-prudential (ie financial stability) aspects via three strands. (i) They are based on a macro-scenario that allows assessing a system-wide shock to banks and to extend the stress testing framework to account for feedback effects. (ii) The results feed into the regular measurement and assessment of a bank’s risks, that is the supervisory review and evaluation process. In 2016, the European Central Bank incorporated the qualitative results of the stress test into the definition of supervisory measures; these results could have an impact on Pillar 2 requirements. The quantitative results of the stress test, namely the capital depletion in the adverse stress test scenario, were used for determining Pillar 2 guidance. Pillar 2 requirement is one input factor for the minimum requirement on own funds and eligible liabilities, while Pillar 2 guidance is a capital expectation above the (macro-prudential) buffers. (iii) Stress tests can reveal recapitalization needs that could lead to private or public recapitalization or to supervisory and early intervention measures, which may activate recovery and resolution plans in the extreme. This overview highlights the linkages between micro-prudential stress tests and macro-prudential aspects, reaching from supervision to capital buffers and to crisis management and bank resolution.