Updated stress testing of the financial sector in the context of high interest rates

Updated stress testing of the financial sector in the context of high interest rates

Fecha: septiembre 2023

Ángel Berges and Jesús Morales

Stress tests

SEFO, Spanish and International Economic & Financial Outlook, V. 12 N.º 5 (September 2023)

In keeping with the stipulated biennial schedule for stress testing significant banks, the European supervisor (ECB/SSM) has completed its exercise for 2023-2025, using year-end 2022 as its starting point. In parallel, its American counterpart (the Federal Reserve) has stress tested its significant banks, publishing its results one month ahead of the ECB. Several aspects distinguish this set of tests from those undertaken since 2014 when, in conjunction with the launch of the Banking Union initiative, it was decided to place stress tests at the heart of the supervisory function. The last round of tests (in 2021) focused on the potential impairment of credit as a result of the pandemic at a time when interest rates of zero per cent were preventing the banks from generating reasonable minimum margins. Compared to the zero-rate environment that shaped all the previous stress tests, the 2023 tests are the first to take place against the backdrop of high rates that are unlocking new risks (market, interest rate and liquidity risks) that did not affect the previous rounds of tests. It is for that reason that the European and American supervisors have tentatively introduced the simulation of bond portfolio loss scenarios related with the spike in interest rates, albeit as an exploratory exercise with no immediate impact on capital requirements. While the general conclusion derived from the exercise is that the European banks are better positioned to offset potential capital depletion via stronger NII generation (as is also apparently reflected in the listed banks’ market values), the upward shift in the rate curves is impacting the economic value of the banks’ investment portfolios. Against this backdrop, the stress tests are and must remain a constantly evolving tool capable of adapting to new sources of risk and new types of scenarios, notably including climate, cybersecurity, geopolitical and pandemic risks, that are not captured in scenarios that only consider stressed financial conditions but can nevertheless wreak havoc on the economy and, by extension, the health of the banking system. The supervisors need to continue to boost the quality and effectiveness of their methodologies in order to look forward and ensure that the banks remain able to carry out their financial intermediation role, especially in times of heightened uncertainty.

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