European Banking Authority plans overhaul of EU bank stress tests
Watchdog wants lenders across the bloc to have more control over how they model results
Lenders will have more leeway to police themselves under a planned overhaul of the biennial bank stress tests carried out by the European Banking Authority.
The watchdog argues that the current methodology — introduced in the wake of the financial crisis to show how much capital would be depleted if a lender came under pressure — has outlived its usefulness.
In proposals floated on Wednesday, the EBA, which ensures bank regulations are applied evenly across the EU, said it to wanted to focus instead on how banks use their capital in more “relevant” scenarios.
It wants lenders across the bloc to have more control over how they model results, with the ability to cast aside existing constraints if they explain why, according to its discussion paper.
“The framework we are proposing today aims at making the EU-wide stress test more informative, flexible, and cost-effective,” said José Manuel Campa, the EBA’s chairman.
Separate sets of results would be published under the plans: one from the supervisors and one from the banks, with the banks having to explain any discrepancies. While banks would have to give far more detail than is now the case, the supervisors would be required to give less.
The EBA argues that the planned redesign would give more information than similar tests in the UK and the US. Its current stress tests have been judged by markets to be the most lenient because there is no pass or fail benchmark and there is a lag between the publication of results and any supervisory follow-up in terms of ordering action that a bank should take.
Simon Gleeson, a regulatory partner at law firm Clifford Chance, said the EU and the US operated almost diametrically opposed exercises.
“What the EBA is saying here is that they want banks to do in effect a parallel stress test, in which they take into account how they would actually respond to the stress, and assess what the impact would be after those responses,” he said. “The result of the bank’s parallel test will by definition be a lower number than the supervisor’s test.”
The EBA said it wants the new tests to be more cost-effective and relevant — but that requires a “trade-off” with reliability.
“Relevance can a priori be increased by relaxing methodological constraints in the stress test methodology, thereby allowing banks, to a larger extent, to leverage on own data and models, which may be better tailored to their individual business models, market environments and business practices,” the EBA paper reads.
“At the same time, methodological constraints act as safeguards to ensure the reliability of the projections. Achieving relevance in the stress test in practice thus requires trade-offs between realism and reliability.”
The EBA move comes after Mr Campa’s predecessor, Andrea Enria, questioned the value of its stress tests, arguing that elements of them were no longer “tenable”. He is now the European Central Bank’s top banking supervisor.
The EBA maintains only a co-ordinating role in the stress tests, with local supervisors left to decide how to run them.
The European body has no power to overrule local supervisory decisions to give an easier ride to banks in the tests, something underscored when the Financial Times revealed that Deutsche Bank had been given special treatment by the ECB in the 2016 exercise.
The EBA will consult until April on the tests’ redesign. This year’s test results will be published in July, having been run on the existing methodology.