UK regulatory commentary on stress tests

From the FSA:

FSA statement on its use of stress tests, May, 28th, 2009

The publication in the US of the results of bank stress tests has provoked considerable interest in the use of stress testing by authorities in other countries, in particular in Europe. This statement clarifies how stress tests have been used within the UK and describes how the UK approach fits within the EU-wide stress testing exercise on the aggregate banking system being co-ordinated by the Committee of European Banking Supervisors (CEBS).

The UK authorities have not applied stress testing in the same way as in the US. Instead, over the last eight months, the FSA has

• Greatly increased the use of stress tests as an integral element of the ongoing supervisory approach.
• Begun the process of embedding this revised approach in the intensive supervisory regime.
•  Used stress tests to inform policy decisions such as access to the Credit Guarantee Scheme (CGS) and the Asset Protection Scheme (APS) working closely with the other Tripartite authorities.

The tests look forward over five years but with greater detail over the first three. They are used to identify if at any time in the next five years there is a danger that under the stress scenario the level of capital will fall below the 4% Core Tier 1 minimum.

The current stress scenario assumes a peak-to-trough fall in GDP of over 6%, with growth not returning until 2011 and only returning to trend growth rate in 2012. It models the impact of unemployment rising to just over 12% and, crucially, the impact of a 50% peak-to-trough fall in house prices and a 60% peak-to-trough fall in commercial property prices.

CEBS has committed to co-ordinating a Europe-wide stress testing exercise to inform assessments of the aggregate health of the banking system. This exercise will use common approaches and scenarios and aims to increase the level of aggregate information available to policy makers in assessing the European financial system’s resilience to shocks.

The FSA will be participating in this exercise and the EU wide scenarios will be agreed by the European Commission and CEBS. The exercise will be completed by September 2009.