How demanding and consistent is the 2018 stress test design in comparison to previous exercises? : banking union scrutiny : in-depth analysis

The 2018 EU-wide stress test requires banks to evaluate the impact on profits and capital of common macroeconomic scenarios for 2018-2020. The methodology set up by the EBA addresses four main sources of uncertainty: credit risk, market risk, financial risks on net interest income and operational risk. Credit risk is assessed on the basis of the new IFRS 9 accounting standard. Market risk includes a valuation of illiquid, hard-to-price level 2/3 financial instruments. Net interest income is assumed to suffer from an asymmetric increase in the rates earned on assets and paid on liabilities. Operating risk includes conduct risk and takes into account past loss events. This written advice highlights some weaknesses in the EBA methodology, which may lead to a different degree of conservativeness for some business models or countries. It also discusses ways to make future stress tests more realistic and reliable, by addressing resource gaps and improving governance.