EBA 2018 Credit Risk Stress Test

From Open Risk Manual

Key Assumptions

  • The projection of provisions is based on a single scenario in each macroeconomic scenario (baseline and adverse)
  • The exposure transitions between the three impairment stages defined in IFRS 9 need to be projected for each year
  • The methodology makes use of the Perfect Foresight Assumption. At any point of time in the projection banks should assume the subsequent path of a variable to be known and equal to what is given in the scenario for the remaining maturity of the exposure
  • For the calculation of lifetime ECL, the full scenarios should be treated as known when calculating expected credit losses. This means that ECL for initial Stage 2 and Stage 3 exposures will be calculated once at the beginning of each scenario. ECL does not change as a result of the development of the scenario from year to year.
  • For exposures in S2 and S3, banks are expected to provide stressed lifetime expected loss rates
  • According to the Static Balance Sheet Assumption, banks are not permitted to replace Stage 3 exposures. New Stage 3 exposures are moved into the stock of Stage 3 exposures, reducing the stock of Stage 1 and/or Stage 2 and keeping the total exposure at a constant level. Furthermore, for the purpose of calculating exposures, it is assumed that no cures from Stage 3, charge-offs or write-offs should take place within the 3-year horizon of the exercise
  • A common definition of S3 assets as non-performing exposures should be applied for the projections

Scope

For the estimation of the P&L impact, the scope of this section covers all counterparties:

  • sovereigns
  • institutions
  • financial firms
  • non-financial firms and
  • households

and all positions (including on-balance and off-balance positions) exposed to risks stemming from the default of a counterparty, except for exposures subject to CCR and fair value positions (FVOCI and FVPL) which are subject to the market risk approach for the estimation of the P&L effect (or through capital, via OCI, for FVOCI).

For the avoidance of doubt, FVOCI and FVPL positions are excluded from the estimation of credit risk losses

The IRB asset class tables contain the asset classes, including the additional optional asset classes that should be used for both credit risk impairments and REA

Profit and Loss

For the estimation of the P&L impact, the scope of credit risk profit and loss covers all counterparties (e.g. sovereigns, institutions, financial and non-financial firms and households) and all positions (including on-balance and off-balance positions) exposed to risks stemming from the default of a counterparty. Notably:

  • Loans and receivables accounted at Amortised Cost
  • Sovereign positions included

Except for exposures subject to CCR and fair value positions (FVOCI and FVPL), which are subject to the market risk approach for the estimation of the P&L effect (or through capital, via OCI, for FVOCI)

Risk Exposure Amount (REA)

In contrast to the scope of PnL impact, the estimation of REA follows the CRR/CRD definition of credit risk. Therefore, exposures subject to CCR and fair value positions (FVOCI and FVPL) are to be included. Notably:

  • Including securitisations
  • Includin CCR and fair value positions

Variable Definitions

The methodology introduces a detailed list of definitions of

  • State Variables
  • Stock and Flow Variables and
  • Risk Parameters

as summarized here

Projecting Realized Impairments

Banks commencing to report under IFRS 9 in 2018 are required to forecast these impairments based on the Expected Credit Loss framework of IFRS 9.

Significant Increase in Credit Risk

Banks shall project significant increase in credit risk in line with their accounting approaches, i.e. apply the Stage 2 classification criteria used in their IFRS 9 models. However, for the purpose of the stress test projections banks shall also assume without prejudice to other triggers that Stage 1 exposures which experience a threefold increase of lifetime PD (as defined under IFRS 9) compared with the corresponding value at initial recognition undergo an SICR and hence become Stage 2. If lifetime PDs for an exposure are unavailable, banks may apply a 1-year PD as a proxy, e.g. a threefold increase of TR 1-3 compared with the corresponding value of forward-looking TR1-3 at initial recognition could instead be used as a backstop for Stage 2.

Low Credit Risk Excemption

For the purpose of the stress test, an instrument may be considered to be of low credit risk in a particular year, t, of the stress test if the instrument's TR1-3(t) for that year is less than 0.30%. Instruments which are of low credit risk may be exempted from the classification as Stage 2

Banks are requested to forecast credit impairments influenced by the materialisation of a set of single scenarios (baseline and adverse) on the basis of IFRS 9 as prescribed in the following methodology:

  • The projection of provisions is based on a single scenario in each macroeconomic scenario (baseline and adverse). It is (for example) not the weighted average of scenarios that would be in practice how IFRS 9 provisions would be computed at future dates
  • Banks shall project significant increase in credit risk in line with their accounting approaches. However, for the purpose of the stress test projections banks shall also assume without prejudice to other triggers that S1 assets which experience a threefold increase of annual point-in-time PD compared to the corresponding value at initial recognition (i.e. a 200% relative increase) undergo a significant increase in credit risk (SICR) and hence become S2
  • For the estimation of Lifetime Expected Credit Losses, after the end of the scenario horizon, the adverse scenario credit risk parameters (i.e. stage transition probabilities and the corresponding LGD across stages) are assumed to revert to the baseline horizon credit risk parameters.
  • The baseline credit risk parameters are assumed to stay flat after year 3
  • A common definition of Stage 3 Assets as Non-Performing Exposures should be applied for the projections. Banks will use their own interpretation of definition of S3 for the starting point of the exercise but shall apply a common definition for the projections during the horizon of the exercise. No restatement of starting Stage 3 exposures must be carried out. For the avoidance of doubt, all non-performing exposures as per EBA ITS 2 , defaulted exposures as per Article 178 of the CRR, or impaired exposures as per the applicable accounting standard shall be classified as Stage 3 under IFRS 9 for the stress test period
  • For the purposes of calculating impairments the assumption of constant residual maturity is also held over the 3 years of projections. However, the assumption does not hold beyond the horizon of the stress test and, for the purposes of calculating lifetime ECL, exposures can begin to mature again as they do in the banks standard IFRS 9 models. In particular, loans in Stage 1 or Stage 2 that mature within the time horizon of the stress test should be assumed to be replaced with loans that are also in Stage 1 respectively in Stage 2.
  • Banks shall also assume without prejudice to other triggers that Stage 1 assets which experience a threefold increase of annual point-in-time PD compared to the corresponding value at initial recognition (i.e. a 200% relative increase) undergo a Significant Increase in Credit Risk (SICR) and hence become Stage 2

Projecting Risk Weighted Exposure Amounts

For the estimation of REA (risk-weighted exposure amounts), banks should adhere to regulatory requirements based on stressed regulatory risk parameters

For securitisation exposures, banks are requested to project impairments based on the risk parameters of the underlying pool. For the estimation of REA, a fixed risk weight increase will be applied to the different credit quality steps

  • No cures from Stage 3 assets are permitted. The only acceptable transitions are from stages 1 to 2, 2 to 1, 1 to 3 or 2 to 3
  • No negative impairments for any given exposure are permitted for any year or scenario, except and exclusively in the case of transitions from Stage 2 to Stage 1
  • The coverage ratio for Stage 1 assets (ratio of provisions to exposure) cannot decrease over the time horizon of the exercise
  • The end-2017 level of REA serves as a floor for the total REA for non-defaulted and defaulted exposures in the baseline and the adverse scenarios. This floor must be applied separately to overall aggregate IRB and STA portfolios

According to the Static Balance Sheet Assumption, the initial residual maturity is kept constant for all assets. This means that assets do not mature. It should be noted that the constant residual maturity applies, in particular, to the Effective Maturity factor used in A-IRB, but also to some provisions in STA, which allow for favourable risk weights for short- term exposures.

For securitisation exposures, the end-2017 level of REA serves as a floor for the total risk exposures separately for aggregate IRB and STA portfolios

Reporting Requirements

  • Banks are requested to provide credit risk information by
    • regulatory approach for the total exposure (STA, F-IRB or A-IRB)
    • the most relevant countries of counterparties to which the institutions are exposed, and an ‘Other Countries’ section.
  • The cells for the whole banking group contain the overall exposure of the group towards all counterparties and should be the sum of the country by country and ‘Other Countries’ cells
  • The country of the counterparty refers to the country of incorporation of the obligor. This concept can be applied on an immediate-obligor basis and on an ultimate-risk basis. Hence, credit risk mitigation (CRM) techniques can change the allocation of an exposure to a country.
  • The breakdown by country of the counterparty will be reported according to a minimum of:
    • 95% of the sum of exposure (Exp) and default stock (Def Stock), as defined in section 2.3.1, reported in aggregate for three regulatory approaches (i.e. A-IRB, F-IRB and STA);
    • Top 10 countries in terms of aggregate sum of exposure (Exp) and default stock (Def Stock), as stated above.
    • Example: A bank with 95% of its exposure concentrated in six countries will only fill data for those six countries specifically.
    • Example: By contrast, if the aggregate sum of exposure of a bank towards the largest 10 countries is below 95% of the total aggregate exposure, the bank will fill the template only for the top 10 counterparty countries specifically. In either case the ‘other countries’ section must also be populated.
  • The cut-off date to define the 95% of aggregate sum exposure and top 10 countries is 31 December 2017. The selected countries of the counterparties and the order must remain constant for the two credit risk templates (CSV_CR_SCEN and CSV_CR_REA)
  • Banks with loans under large-scale or nation-wide guarantee schemes where the indirect exposure on the guarantor is significant should report the guaranteed exposures separately from the non-guaranteed ones using the additional rows which have been added to the credit risk templates (CSV_CR_SCEN and CSV_CR_REA). Banks should explain how LGDs for guaranteed exposures were modelled and projected

Credit Risk Reporting Templates

Template Name Template Description
CSV_CR_SUM Credit risk - Summary
CSV_CR_SCEN Credit risk - Scenarios (projection for credit risk losses)
CSV_CR_REA Credit risk - REA
CSV_CR_REA_IRB REA - IRB approach floor
CSV_CR_REA_STA REA - STA floor
CSV_CR_SEC_SUM Securitisations - Summary
CSV_CR_SEC_STA Securitisations - STA (REA)
CSV_CR_SEC_IRB Securitisations - IRB except exposures under supervisory formula (REA)
CSV_CR_SEC_IRB_SF Securitisations - IRB supervisory formula (REA)
CSV_CR_SEC_OTHER Securitisations - Other positions (look through) (REA)

Contributors to this article

» Wiki admin