Stress Tests in Spain. One supervisory view

1. Stress Tests in Spain. One supervisory view PMO-Banco de España Jornada del Club de Gestión de Riesgos. LA visión del regulador y el impacto en la banca Madrid, 24 de julio de 2014

2. Caveat The opinions expressed here are those of the author and not necessarily those of the Banco de España

3. Spain: a long history of Stress Tests Flesb 2013

4. Comparing the last two exercises 52,000

5. Progressing on a good path AQR pre-ST is an important improvement in level playing field setting a common start line Bottom-Up approach with strong Top-Down QA. Increasing interaction among Banks, NCA y CPMO The vast majority of the Spanish non IRB Banks opted for a Bottom-Up approach in 2014 The Stress Tests have revealed as a strong incentive for raising capital

6. Risks to avoid I: overoptimistic approaches • The Measure VS one measure in the supervisory toolkit • Overreliance in a single, apparently accurate figure • Danger of overconfidence • Starting from the scratch, no previous knowledge of the institutions: • Supposedly more objective and playing field leveling • In practice, broad brush and lack of flexibility

7. A sensible target The target can´t be a “magic” figure (depending on changing hurdles), but a relative ranking of the institutions This could seem too little, but it is not an easy mission: It´s a first stage to be followed by further supervisory measures and inquiries Capital requirements based on a deeper knowledge of the banks

8. Risks to avoid II: Methodology vs Reality • Modeling reality is complex but inflexibility is not a solution • Credibility is (also) based on avoiding easy criticism • Counterintuitive rules need to be addressed: • Growing non performing and decreasing performing loans stock • No incomes on defaulted assets but discounted flows in the impairment • Matured exposures replaced with similar (stressed) risk ones but not applying wider spreads • Rigidity of floors and caps in non interest income and expenses…

9. A way of adapting static approach Example: an institution made in 2013 an important staff restructuring resulting in substantial reduction of the ordinary expenses Should they project the restructuring expenses in the ST horizon? Static floor approach: headcount as of dec 2013 level multiplied by the average wage of 2013

10. Risks to avoid III: Black box approach Outcomes from bank models need to be explained based on main data and drivers But also the benchmarks used in the quality assurance need to be explained Expert judgment and interaction between outcome providers and challengers are key and better than mechanistic approaches

11. Flesb: BdE approach to the ST • Sensitivity analysis of capital ratio to different scenarios • Centrally led with loan by loan and collateral information • Doesn't determine directly capital add-ons but: • Ranks institutions (horizontal comparisons) • Detects supervisory priorities • Complements the supervisory knowledge of the institutions • Is part of the supervisory (dialogue) process with entities • Limited disclosure

12. Flesb overview

13. Takeaways Stress Testing have come to remain Both supervisors and banks have to integrate this tool in their basic routines Wide Stress Tests are useful and have improved their methodology through out the experience At the same time, they are time demanding and expensive so they have to be administered wisely