The Need for "Un-consolidating" Consolidated Banks' Stress Tests
IMF Working Papers, December 6, 2012
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Bibliographic details
- Authors: Eugenio M Cerutti, Christian Schmieder
- Published: December 6, 2012
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781475519051.001
Summary and core argument
- The recent crisis has spurred the use of stress tests as a (crisis) management and early warning tool.
- A key weakness of current consolidated stress tests is the assumption that capital and liquidity are available wherever they are needed within the banking group.
- That assumption neglects:
- that regulations differ across countries (e.g., minimum capital requirements), and
- that home/host regulators might limit flows of capital or liquidity within a group during periods of stress.
- The study presents a framework to integrate limits on intragroup flows into stress tests and provides illustrative calculations for banks included in the June 2011 EBA stress tests.
Framework and methodological approach
- Presents a framework on how to integrate the risk that intragroup capital and liquidity transfers will be limited by home/host regulatory differences and actions into stress tests.
- Focuses on embedding the banking groups’ geographical structure into stress-testing exercises rather than relying solely on consolidated numbers.
- Uses illustrative calculations to quantify the potential adjustments needed when intragroup flows are restricted.
Illustrative calculations and empirical exercise
- Provides illustrative calculations on the size of the potential adjustments needed in the presence of some limits on intragroup flows for banks included in the June 2011 EBA stress tests.
- The empirical exercise is based on banks included in the June 2011 EBA stress tests (as specified in the source).
Findings and implications
- Stress tests that assume unrestricted internal transferability of capital and liquidity can understate vulnerabilities created by cross-border regulatory fragmentation and potential ring-fencing.
- Integrating constraints on intragroup flows can materially affect stress-test outcomes and the assessment of bank resilience in cross-border banking groups.
- The approach highlights the importance of considering host-country regulatory constraints and potential actions by home or host regulators during stress episodes.
Policy recommendations and prudential implications
- Stress-testing frameworks should "un-consolidate" aspects of consolidated tests by explicitly modeling limits on intragroup capital and liquidity flows arising from differing national regulations and potential regulator actions.
- Regulators and supervisors should incorporate geographic fragmentation and ring-fencing risks into stress-test designs to better capture systemic and idiosyncratic vulnerabilities of cross-border banking groups.
- Greater attention is warranted to host country regulator constraints and to how minimum capital requirements and other regulatory differences across countries can interact with stress scenarios.