Banking system stress testing and COVID-19: A first summary appraisal

Abstract

This paper dicusses the special banking system stress tests which central banks for the USA, the UK and the euro area published shortly after the outbreak of COVID-19. Based on the limited quantitative information available on a comparable basis, this paper discusses how the results seem broadly consistent across institutions as well as with previously conducted exercises, once accounting for the respective differences in scenario severity. The paper also discusses how central banks identified specific design features characterising these COVID-19 exercises, employing the typology put forward in the Bank for International Settlements’ (BIS) Financial Stability Institute (FSI) insights #12 — considering three building blocks: governance, implementation and outcomes. In particular, these special exercises set a new, more demanding benchmark for scenario adversity. Top-down modelling was also used to a larger extent to deal with uncertainty via alternative scenarios and to assess the impact of policies. Moreover, only aggregate results were published, with limited information on the results across banks. Finally, the connection with supervisory decisions appeared loose at most. The latter two features are not expected to remain in subsequent regular supervisory system-wide exercises. At the same time, the granularity of information collected, the banks in scope or the treatment of spillovers and feedbacks largely remained in line with standard supervisory stress-testing practices. This admittedly came short of what could be needed to get a more complete assessment of the impact of this specific crisis, from both a microprudential or macroprudential perspective. In particular, sector-specific information was sparse and banks’ credit deleveraging explored only for the UK. Looking ahead, it appeared that stress-testing models can represent a valuable forecasting and monitoring tool, especially when baseline conditions are adverse enough and uncertainty prevails. The review also suggests that bottom-up and top-down system-wide supervisory stress-test results could coexist, thereby giving further concrete relevance to recent proposals on the future of European Union area-wide stress tests.