A stress test examines the potential impact of a hypothetical adverse scenario on the health of the banking system and individual institutions within it. In doing so, stress tests allow policymakers to assess banks’ resilience to a range of adverse shocks and ensure they are sufficiently capitalised, not just to withstand those shocks, but also to support the real economy in a potential future stress.
The Bank of England (BoE) has now published an approach document that sets out the main features of its stress testing framework to 2018. The framework has been shaped by the lessons the BoE has learnt during stress tests in 2013 and 2014 and feedback to an earlier Discussion Paper.
Over the next three years, the BoE is aiming to:
- develop an approach to stress testing that is explicitly countercyclical, with the severity of the test, and associated regulatory capital buffers, varying systemically with the state of the financial cycle;
- improve the consistency between the concurrent stress test and the overall capital framework, including by ensuring that systemically important banks are held to higher standards; and
- enhance its own modelling capability, while ensuring that participating banks continue to play an important role in producing their own projections of the impact of stress.
Key features of the BoE’s approach include:
- a concurrent stress test of banks will be run annually. Each year, there will be a scenario whose severity will reflect policymakers’ assessment of the state of the financial cycle;
- every other year, there will be a second scenario to explore a wider range of risks that might threaten financial stability;
- an enhanced role for the BoE modelling, with a focus on system-wide dynamics;
- an integrated framework for deliberations and decisions around the setting of capital buffers, supporting the overall capital framework;
- a clear and transparent framework for determining whether banks need to strengthen their capital positions, including a ‘hurdle rate’ framework that aligns with the overall capital framework; and
- a framework that includes all major UK banks and building societies.
In relation to timing key steps include:
- the BoE plans to publish the results of the 2015 stress test on 1 December 2015;
- the BoE will release the annual cyclical stress-test scenario in March 2016 and will only be making essential changes to its stress testing data requests for the 2016 test. Results will be published in Q4 2016;
- the BoE intends to run its annual cyclical stress test and its biennial exploratory scenario side by side. Institutions required to participate in these exercises will be informed during 2016. Scenarios will be released by the end of Q1 2016 and results will be published in Q4 2016. The BoE intends to move to a new common data platform in 2017; and
- the BoE intends to run its annual cyclical stress test only. Scenarios will be released by the end of Q1 2016 and results will be published in Q4 2016.
View The Bank of England’s approach to stress testing the UK banking system, 21 October 2015