A. Introduction

127. “Stress testing” refers to the use of various techniques to estimate potential vulnerabilities of financial systems to exceptional, but plausible, events. Stress tests of the banking sector require the specification of risks, usually, credit, interest rate and exchange rate risks. More complicated stress tests could include shocks to liquidity, equity prices, property prices and non-interest income, among other variables. Stress tests estimate the impact of a single shock (sensitivity analysis) or multiple shocks (scenario analysis).⁷³

128. Stress tests tend to have wide coverage of the banking sector, and tend to comprise simple sensitivity analyses. According to Cihak and Hermanek (2006), they usually cover either all, or almost all, banks in terms of market share.⁷⁴ Other segments of the financial sector are rarely covered. Further, stress tests tend to be very rudimentary, as many central banks are still only in the early part of their work in this area. ⁷⁵ Credit risk is covered in almost all stress tests; interest rate risk is also covered in most of them (Table 1). Exchange rate risk is covered in some, but in many cases, is analyzed only in terms of open positions, and not as an explicit stress test. Some stress tests include scenario analysis, based on historical (a significant event experienced in the past) or hypothetical (a plausible event that has not yet occurred) scenarios. Only a few utilize econometric models, and even then, the models tend to be relatively simple.

Table 1.

Comparison of Stress Tests in Selected European Financial Stability Reports with the BNB Model

Source: Cihak and Hermanek (2005) and Bulgarian National Bank.

^*Credit substitutes and derivatives.

Table 1.

Comparison of Stress Tests in Selected European Financial Stability Reports with the BNB Model

	Percent of FSRs	BNB
Stress tests included	55	Yes
Stress tests follow those in a recent FSAP	50	Yes
Credit risk stress test included	55	Yes
Interest rate risk stress tests included	45	Yes
Exchange rate risk stress tests included	33	Yes
Other risks included	33	Yes *
Scenario analysis included	38	Yes
Contagion analysis included	10	No
Credit risk based on a macro-model or other detailed model	8	No

Source: Cihak and Hermanek (2005) and Bulgarian National Bank.

^*Credit substitutes and derivatives.

View Table

Table 1.

Comparison of Stress Tests in Selected European Financial Stability Reports with the BNB Model

	Percent of FSRs	BNB
Stress tests included	55	Yes
Stress tests follow those in a recent FSAP	50	Yes
Credit risk stress test included	55	Yes
Interest rate risk stress tests included	45	Yes
Exchange rate risk stress tests included	33	Yes
Other risks included	33	Yes *
Scenario analysis included	38	Yes
Contagion analysis included	10	No
Credit risk based on a macro-model or other detailed model	8	No

Source: Cihak and Hermanek (2005) and Bulgarian National Bank.

^*Credit substitutes and derivatives.

129. In Bulgaria, stress testing of the banking system is performed by the Banking Supervision Department (BSD) of the Bulgarian National Bank (BNB). Presently, individual banks in Bulgaria are not required to perform their own stress testing. That said, some big banks do so as part of their risk management exercise, and these results are made available to the BSD’s on-site examiners.⁷⁶ Banks which choose to apply the internal ratings-based (IRB) models under the Basel II capital requirements (likely to be implemented in 2007) must present their stress tests, as well as internal models for supervisory approval.⁷⁷

130. The BNB’s stress testing framework is consistent with existing models at other central banks. It includes key shocks, such as to credit quality, interest rates and exchange rates, and takes into account shocks to derivatives positions (Table 1). Scenario analysis is also included in the BNB tests. Further, the BNB takes a very conservative approach to its stress tests. By including crisis-like scenarios in the stress tests—based on experiences during the 1996-97 financial crisis—the authorities are aware of the extreme case outcomes for the banking sector at all times.

131. The BNB also complements its stress tests with an Early Warning System (EWS).⁷⁸ In this exercise, more than 100 ratios are calculated—well above the FSAP recommended set of core and encouraged financial stability indicators (FSIs); these ratios are analyzed on a time-series and cross-sectional basis, and are also used in their CAEL/CAMELS ratings.⁷⁹

132. The BNB also performs regular on-site inspections, the frequency of which is based on the CAMELS ratings of individual banks, or if the off-site analyses discovers issues of concern. Full-scope audits are performed by on-site teams, which include information technology (IT) expertise.

133. The objective of this paper is to provide an overview of the BNB’s stress testing of the banking sector. Section B presents the stress test framework. This is followed by a discussion of the aggregate results for the banking sector in section C, along with the potential implications of test outcomes. Section D concludes with a few recommendations for development of the BNB’s stress testing framework moving forward.

B. The Stress Test Framework

134. The BNB uses a “bottom up” approach in its stress test of the banking sector, using detailed data which are submitted by banks on a regular basis. The effects of shocks on individual banks are initially estimated on a bank-by-bank basis, then on groups of banks and finally, on the banking system as a whole.⁸⁰

135. The BNB’s model involves introducing shocks to selected variables in the profit and loss account and the balance sheet. Three types of risks are evaluated in the stress tests, namely: (i) credit risk, which is considered the most important risk for the local banking system; (ii) interest rate risk; and (iii) exchange rate risk. Each risk variable is initially “shocked” separately.

136. The BSD also tests separate scenarios incorporating all three risk variables. Three scenarios are assumed, each representing a progressive deterioration in the environment. The shock levels for exchange rates and interest rates remain the same in each scenario, while shocks to credit quality, derivatives and credit substitutes are intensified. A summary of the individual shocks and the three scenarios are presented in Table 2.

Table 2.

Bulgaria: Stress Test Variables and Shock Scenarios

(Shocks in percentage terms)

Source: BNB.

Table 2.

Bulgaria: Stress Test Variables and Shock Scenarios

(Shocks in percentage terms)

Risk Factor	Variable	Weighting	Scenario
			1	2	3
Credit	Loans to budget	0.1
	Commercial real estate loans	1.1
	Other commercial loans	1.0
	Agricultural loans	1.0
	Consumer loans	0.8
	Morgage loans	0.5
	Other commercial loans	1.2
	Standard loans migrating to loss		10	Shock multiplier of 1.5	Shock multiplier of 2
	Watch loans migrating to loss		45	Shock multiplier of 1.5	Shock multiplier of 2
	Substandard loans migrating to loss		75	Shock multiplier of 1.5	Shock multiplier of 2
	Doubtful loans migrating to loss		100	--	--
	Non-performing loans migrating to loss		100	--	--
Exchange rate	Net open position		-60	-60	-60
Interest rate	Mismatch in BGN		+192	+192	+192
	Mismatch in EUR		+2	+2	+2
	Mismatch in USD		+2	+2	+2
	Mismatch in other currencies		+5	+5	+5
Other	Credit substitutes migrating to loss		10	Shock multiplier of 2	Shock multiplier of 5
	Derivatives for trading migrating to loss		100	Shock multiplier of 2	Shock multiplier of 5

Source: BNB.

View Table

Table 2.

Bulgaria: Stress Test Variables and Shock Scenarios

(Shocks in percentage terms)

Risk Factor	Variable	Weighting	Scenario
			1	2	3
Credit	Loans to budget	0.1
	Commercial real estate loans	1.1
	Other commercial loans	1.0
	Agricultural loans	1.0
	Consumer loans	0.8
	Morgage loans	0.5
	Other commercial loans	1.2
	Standard loans migrating to loss		10	Shock multiplier of 1.5	Shock multiplier of 2
	Watch loans migrating to loss		45	Shock multiplier of 1.5	Shock multiplier of 2
	Substandard loans migrating to loss		75	Shock multiplier of 1.5	Shock multiplier of 2
	Doubtful loans migrating to loss		100	--	--
	Non-performing loans migrating to loss		100	--	--
Exchange rate	Net open position		-60	-60	-60
Interest rate	Mismatch in BGN		+192	+192	+192
	Mismatch in EUR		+2	+2	+2
	Mismatch in USD		+2	+2	+2
	Mismatch in other currencies		+5	+5	+5
Other	Credit substitutes migrating to loss		10	Shock multiplier of 2	Shock multiplier of 5
	Derivatives for trading migrating to loss		100	Shock multiplier of 2	Shock multiplier of 5

Source: BNB.

137. The BNB’s current stress tests are based on very conservative assumptions of extreme outcomes. For the 2001-02 period, the stress tests are based on assumptions agreed between the BNB and the IMF during the 2002 FSAP. Since 2003, the BNB has tested sensitivities and scenarios based on its own research into the 1996-97 financial crisis. The tests assume a recurrence of the most severe movements in the exchange and interest rates, and the strongest deterioration in credit quality ever recorded for Bulgaria. For example, the assumption of a 60 percent exchange rate shock is based on the experience during the 19966-97 crisis when the exchange rate declined by the same magnitude against other currencies in the space of one day. Similarly, the most severe interest rate shock in history was a 192 percentage points rise in local interest rates in one day during that crisis. The design and selection of the parameters are based on research into different stress test models by a working group at the BNB.

C. Stress Test Results

Analysis

144. Stress test results are provided by the BNB for the 2003-05 period. The results are presented for Group 1 and Group 2 banks, and for banks grouped according to their foreign and domestic ownership (Table 3). The results for 2001 and 2002 are not presented, since they are not comparable given the different assumptions used during that period, and the information available at the time.

Table 3.

Bulgaria: Summary of BNB Stress Test Results by Group and Ownership, 2000-2005

Source: Bulgarian National Bank.

^*Assumes 10 percent migration of standard loans to loss.

Notes: 1. Group 1 comprises the 10 largest banks; Group 2 is represented by 18 medium-sized and small banks. 2. Highlighted results denote outcomes with CARs below the minimum requirement of 12 percent.

Table 3.

Bulgaria: Summary of BNB Stress Test Results by Group and Ownership, 2000-2005

Scenario	Capital Adequacy Ratio (CAR)	End-2003					End-2004					End-2005
		Total	Group 1	Group 2	Foreign	Domestic	Total	Group 1	Group 2	Foreign	Domestic	Total	Group 1	Group 2	Foreign	Domestic
Credit shock *	Before shock	22	22	23	23	18	16	15	19	17	15	15	14	18	15	15
	After shock	16	17	16	18	11	5	4	7	6	1	5	4	7	5	3
	Change	-6	-5	-7	-5	-7	-11	-11	-12	-11	-14	-10	-10	-11	-10	-12
Exchange rate shock	Before shock	22	22	23	23	18	16	15	19	17	15	15	14	18	15	15
	After shock	21	21	22	22	18	16	15	19	16	14	15	15	18	15	15
	Change	-1	-1	-1	-1	0	0	0	0	-1	-1	0	1	0	0	0
Interest rate shock	Before shock	22	22	23	23	18	16	15	19	17	15	15	14	18	15	15
	After shock	23	23	23	25	19	16	16	19	17	14	14	14	16	15	13
	Change	1	1	0	2	1	0	1	0	0	-1	-1	0	-2	0	-2
Scenario 1*	Before shock	22	22	23	23	18	16	15	19	17	15	15	14	18	15	15
	After shock	17	17	15	18	11	4	4	6	6	0	4	4	6	5	-2
	Change	-5	-5	-8	-5	-7	-12	-11	-13	-11	-15	-11	-10	-12	-10	-17
Scenario 2*	Before shock	22	22	23	23	18	16	15	19	17	15	15	14	18	15	15
	After shock	13	15	11	16	7	-3	-4	-3	-1	-17	-4	-5	-1	-1	-17
	Change	-9	-7	-12	-7	-11	-19	-19	-22	-18	-32	-19	-19	-19	-16	-32
Scenario 3*	Before shock	22	22	23	23	18	16	15	19	17	15	15	14	18	15	15
	After shock	8	11	2	11	-5	-23	-22	-27	-17	-41	-20	-21	-17	-16	-35
	Change	-14	-11	-21	-12	-23	-39	-37	-46	-34	-56	-35	-35	-35	-31	-50

Source: Bulgarian National Bank.

^*Assumes 10 percent migration of standard loans to loss.

Notes: 1. Group 1 comprises the 10 largest banks; Group 2 is represented by 18 medium-sized and small banks. 2. Highlighted results denote outcomes with CARs below the minimum requirement of 12 percent.

View Table

Table 3.

Bulgaria: Summary of BNB Stress Test Results by Group and Ownership, 2000-2005

Scenario	Capital Adequacy Ratio (CAR)	End-2003					End-2004					End-2005
		Total	Group 1	Group 2	Foreign	Domestic	Total	Group 1	Group 2	Foreign	Domestic	Total	Group 1	Group 2	Foreign	Domestic
Credit shock *	Before shock	22	22	23	23	18	16	15	19	17	15	15	14	18	15	15
	After shock	16	17	16	18	11	5	4	7	6	1	5	4	7	5	3
	Change	-6	-5	-7	-5	-7	-11	-11	-12	-11	-14	-10	-10	-11	-10	-12
Exchange rate shock	Before shock	22	22	23	23	18	16	15	19	17	15	15	14	18	15	15
	After shock	21	21	22	22	18	16	15	19	16	14	15	15	18	15	15
	Change	-1	-1	-1	-1	0	0	0	0	-1	-1	0	1	0	0	0
Interest rate shock	Before shock	22	22	23	23	18	16	15	19	17	15	15	14	18	15	15
	After shock	23	23	23	25	19	16	16	19	17	14	14	14	16	15	13
	Change	1	1	0	2	1	0	1	0	0	-1	-1	0	-2	0	-2
Scenario 1*	Before shock	22	22	23	23	18	16	15	19	17	15	15	14	18	15	15
	After shock	17	17	15	18	11	4	4	6	6	0	4	4	6	5	-2
	Change	-5	-5	-8	-5	-7	-12	-11	-13	-11	-15	-11	-10	-12	-10	-17
Scenario 2*	Before shock	22	22	23	23	18	16	15	19	17	15	15	14	18	15	15
	After shock	13	15	11	16	7	-3	-4	-3	-1	-17	-4	-5	-1	-1	-17
	Change	-9	-7	-12	-7	-11	-19	-19	-22	-18	-32	-19	-19	-19	-16	-32
Scenario 3*	Before shock	22	22	23	23	18	16	15	19	17	15	15	14	18	15	15
	After shock	8	11	2	11	-5	-23	-22	-27	-17	-41	-20	-21	-17	-16	-35
	Change	-14	-11	-21	-12	-23	-39	-37	-46	-34	-56	-35	-35	-35	-31	-50

Source: Bulgarian National Bank.

^*Assumes 10 percent migration of standard loans to loss.

Notes: 1. Group 1 comprises the 10 largest banks; Group 2 is represented by 18 medium-sized and small banks. 2. Highlighted results denote outcomes with CARs below the minimum requirement of 12 percent.

145. The results show a stronger deterioration in the CAR of banks in 2004 and 2005, compared to 2003, for the same levels of credit shock. Further, the deterioration in 2004 is slightly worse than for 2005. In both cases, the CAR of the banking sector would have dropped well below the required minimum 12 percent.

146. Separate exchange rate and interest rate shocks appear to have little effect on the CAR of banks. The results are robust for all three years. In each case, shocks to either variable have resulted in changes in CAR of up to 2 percent, and all groups have remained well above the required 12 percent.

147. The scenario tests suggest that the capital in the banking sector would have been severely affected if a crisis of extreme magnitude had occurred in 2004 or 2005. The outcome for Scenario 1 suggests that some capital injection into the banking system would have been necessary. In both Scenarios 2 and 3, the CAR would have dropped well below zero.

148. The shocks consistently have a more negative effect on domestic banks relative to foreign banks. In each shock scenario, the impact on the CAR of domestic banks is substantially greater compared to their foreign counterparts, suggesting that domestic banks are more vulnerable, in aggregate, notwithstanding the fact that some domestic banks within the group are sound.

149. Group 1 banks have become increasingly more vulnerable to shocks than the Group 2 ones. This outcome became more distinct for 2005, compared to a relatively mixed outcome in 2004.

Potential Outcomes

150. The capital injection required to return banks to the minimum capital requirement of 12 percent has been calculated by the BNB. Specifically, estimates for the different magnitudes of credit shock are calculated for the aggregate banking sector, and then isolated to banks whose CAR would drop below 12 percent (Table 4). The BNB’s tests show that the most extreme credit shock outcome (10 percent migration of standard loans to loss) could cost up to 4.2 percent of GDP in terms of capital injections into problem banks. However, it should be noted that this estimate does not take into account the fact that banks have had to exclude current profits from their CAR calculations since April 2005.⁸⁵ This amounted to an additional buffer of BGN 600 (1.5 percent of GDP) being excluded from CAR as at end-2005.

Table 4.

Bulgaria: Estimates of Capital Injection Required After a Credit Shock, 2005

(In percent of GDP)

Source: BNB.

Table 4.

Bulgaria: Estimates of Capital Injection Required After a Credit Shock, 2005

(In percent of GDP)

Migration of Standard Loans	Capital Injection (In percent of GDP)
to Loss (In percent)	Aggregate banking sector	CAR below 12 percent
10	3.1	4.2
5	1.4	2.1
3	0.7	1.4

Source: BNB.

View Table

Table 4.

Bulgaria: Estimates of Capital Injection Required After a Credit Shock, 2005

(In percent of GDP)

Migration of Standard Loans	Capital Injection (In percent of GDP)
to Loss (In percent)	Aggregate banking sector	CAR below 12 percent
10	3.1	4.2
5	1.4	2.1
3	0.7	1.4

Source: BNB.

151. The required capital injection for scenarios 1, 2 and 3 are not presented. This is because the necessary amounts are not likely to be meaningful, given the extremity of the combined shocks/crises.⁸⁶ That said, the authorities have made such estimates internally, and are fully cognizant of the amounts needed to recapitalize individual banks and the banking system as a whole, in the event that one of the extreme scenarios does occur.

152. In the event of one of the more extreme scenarios, the BNB would be unable to act as a lender of last resort, given the existing currency board arrangement. According to the Law on Banks, article 21 paragraph 2:

“The Central Bank shall in all cases revoke the license issued to a bank due to insolvency, where: (1) the bank fails to pay its obligations due for more than 7 days; or (2) the total of its liabilities exceeds the total of its assets”

Any decision subsequently taken by the government with regard to potential capital injections for banks would likely be made on a case-by-case basis.

D. Recommendations

153. The BNB’s “bottom up” stress tests of the banking sector include both sensitivity and scenario analyses. The model involves introducing certain shocks to selected variables in the profit and loss account and the balance sheet. These shock factors are consistent with those used by other central banks in that key risks—namely, credit, interest rate and exchange rate—are taken into account. In each test, very stringent assumptions are adopted, based on the extreme shocks to the banking system which have occurred in Bulgaria’s history. As a result, the BNB’s stress tests are very conservative as they essentially test for potentially severe crisis situations.

154. The BNB has indicated that it is constantly trying to enhance its modeling of the financial sector. This is in line with the practices by central banks in advanced economies, such as the U.K. and Norway.⁸⁷ As a first step, the authorities plan to calibrate the stress test assumptions as applicable, and as more historical data become available.

155. Several enhancements would improve the robustness of the tests:

• Testing for liquidity risk. This would provide a clear understanding of the potential stresses on the inter-bank market, given the limited capacity of the central bank to intervene under a currency board arrangement. From an individual bank perspective, it would be useful to determine the extent of a bank’s capacity to sustain a liquidity drain.⁸⁸ As a subsequent step, the bank run could be combined with a sudden stop in capital inflows. The latter scenario is particularly pertinent, given banks’ dependence on overseas funding.⁸⁹

• Testing for other different scenarios. These could be based on the observed historical volatility of the variables being shocked (for example, two standard deviations of exchange rate fluctuations), in addition to using the 1996-97 crisis as a benchmark.

• Testing for the market risk of a range of instruments (local and foreign bonds and equities). This will become more important, as they increasingly account for a bigger share of banks’ investment and trading portfolios.

156. The stress tests could also include broader scenarios of financial sector contagion, as more reliable data become available over time with the maturing of the economy and the development of the banking sector. For instance, they could incorporate contagion from bank runs, failure of a systemically important bank, or the impact of macro-economic shocks. Possible enhancements include:

• Incorporating macro-economic shocks.⁹⁰ One example is an adverse supply-side shock, such as a sharp increase in oil prices, which could impact domestic and foreign demand. This would likely result in the deterioration in the credit quality of corporates and, subsequently, households. The analysis could examine the direct impact on individual banks and through the inter-bank relationships.

• Testing for contagion within the banking sector. Assume the failure of a systemically important bank within the system (e.g., from the second scenario above). The analysis could examine its impact on other banks, and the channels through which it occurs.

Table A.1.

Examples of Stress Tests in Recent European Financial Stability Reports

Source: Cihak and Hermanek (2005), based on central banks’ recent financial stability reports. Austrian National Bank: Financial Stability Report 7, June 2004. Danmarks Nationalbank: Financial Stability 2003. Deutsche Bundesbank: Report on the Stability of the German Financial System, Monthly Report, October 2004. De Nederlandsche Bank: Overview of Financial Stability in the Netherlands, December 2004, Issue No. 1. Hungarian National Bank: Report on Financial Stability, June 2003. National Bank of Poland: Financial Stability Review, First Half of 2004. Norges Bank: Financial Stability, 2004:1, June 2004. Sveriges Riksbank: Financial Stability Report, 2004:2.1)The latest FSR contained the stress tests carried out by (or in collaboration with) an FSAP mission.2)Based on end-2003 FSR. The subsequent two FSRs present only the “stress CAR,” which shows a bank’s financial position in a situation where all NPLs are written off.

Table A.1.

Examples of Stress Tests in Recent European Financial Stability Reports

Country	Coverage	Main conclusion	Credit shock	Interest rate shock	Exchange rate shock	Other shock	Scenario	Indirect FX risk	Contagion
Austria 1)	All banks	ST supported positive assessment of banks’ risk-bearing capacity.	Incr. in loan loss provisions to loans of 30 percent.	Upward shifts in EUR, USD, CHF curves; downward shift in YEN curve.	Appreciation/depreci ationof EUR by 10 percent. Worst case estimation.	Equity price risk	Yes	Yes	Yes
Czech Republic	All banks	System basically stable. Recent shift from credit risk to interest rate risk.	Increase in NPLs of 30 percent or in the NPL/TL ratio of 3 percentage points.	Increase of 1 pet point/2pct points. Combination of weighted gap and duration methods.	Domestic currency depreciates by 15 or 20 percent.		Yes, two scenarios	Yes	Yes
Denmark	6 Nordic groups and 46 (out of 99) Danish institutions.	The banking institutions have increased their resilience considerably.	Increase in losses on loans to non-public sector of 1 or 2.25 percentage points.	Increase in interest rates of 1 or 3 pet points. Decrease in the average lending rate of 1 pet point.		Decrease in stock prices of 30%). Decrease in net fee and commission income of 40%o.	Yes, several combinations of the shocks listed here.	No	No
Germany	A sample of banks; insurance companies	No risk to financial stability at present.	Credit risk estimated by an econometric model.	Twists of the yield curve at the short end, parallel shifts across all maturities, and fluctuations in the medium-term range.	EUR appreciates or depreciates by 15%.	30%o decline in stock prices in all markets.	Yes, “oil price No scenario,” “int. rate scenario.” Credit risk scenario using an econo-metric model.	No	No
Hungary 2)	All active banks	Results indicate an improvement in the sectors’ resilience.	4 shocks to NPLs (e.g., doubling, increase of 2 std. dev.)	Domestic rates: +500 bps, -300 bps Foreign: +/-200 bps	+/- 40%	No	No	No	No
Latvia	All banks	Vulnerability to overall credit risk decreased in 2004; household lending the biggest risk.	Increase in NPL ratio of 3 percentage points. A number of sectoral shocks, assuming that a percentage of loans to some sectors become NPLs.	No explicit stress test included; the report notes that most loans are floating rate.	USD depreciating by 10% against EUR.		No	No	No
Poland	All banks	The system exhibits high stability.	Three shocks: (i) satisfactory and special mention loans migrate to doubtful; (ii) substandard and doubtful migrate to loss; and (iii) bankruptcy of three largest borrowers.	Not a stress test, but an analysis of gains/losses on interest-sensitive instruments, and the maturity of debt securities.	Not a stress test, but an analysis of VaR and open positions.	Equity price risk and property market risks analyzed (but without a stress test)		No	No
Netherlands 1)	Major fin. institutions (84% banks, 54% insurance, 50%) pension)	Banks are sufficiently shock-resistant.	+/-50 bps change in credit spreads (larger for insurance and pensions)	+/-100 bps parallel move; 50 bps flattening/steepening of yield curves (larger for insurance and pension)	+/-10% change in the exchange rate of EUR vs. other currencies	+/-15% change in all relevant stock indices; 25%> increase in market volatilities	Yes, “domestic crisis of confidence,” “dollar crisis”	No	Yes
Norway	All banks/seven largest conglomerates.	Short-term stability outlook satisfactory. However, increased vulnerability of household sector.	Decline in economic growth, increased unemployment.	Interest rates unchanged, but interest burden of real sector increased appreciably.		A fall in property prices reduces mortgage values, causing a rise in loss given default.	Yes, all tied to credit risk.	No	No
Sweden	Four major banks	The major banks have improved their potential for coping with shocks.	Failure of the largest counterparty, assumed recovery ratio of 25 percent.	Increase in interest rates of 1 pet point, and 30 percent fall in the stock market.			No	No	Yes

Source: Cihak and Hermanek (2005), based on central banks’ recent financial stability reports. Austrian National Bank: Financial Stability Report 7, June 2004. Danmarks Nationalbank: Financial Stability 2003. Deutsche Bundesbank: Report on the Stability of the German Financial System, Monthly Report, October 2004. De Nederlandsche Bank: Overview of Financial Stability in the Netherlands, December 2004, Issue No. 1. Hungarian National Bank: Report on Financial Stability, June 2003. National Bank of Poland: Financial Stability Review, First Half of 2004. Norges Bank: Financial Stability, 2004:1, June 2004. Sveriges Riksbank: Financial Stability Report, 2004:2.1)The latest FSR contained the stress tests carried out by (or in collaboration with) an FSAP mission.2)Based on end-2003 FSR. The subsequent two FSRs present only the “stress CAR,” which shows a bank’s financial position in a situation where all NPLs are written off.

View Table

Table A.1.

Examples of Stress Tests in Recent European Financial Stability Reports

Country	Coverage	Main conclusion	Credit shock	Interest rate shock	Exchange rate shock	Other shock	Scenario	Indirect FX risk	Contagion
Austria 1)	All banks	ST supported positive assessment of banks’ risk-bearing capacity.	Incr. in loan loss provisions to loans of 30 percent.	Upward shifts in EUR, USD, CHF curves; downward shift in YEN curve.	Appreciation/depreci ationof EUR by 10 percent. Worst case estimation.	Equity price risk	Yes	Yes	Yes
Czech Republic	All banks	System basically stable. Recent shift from credit risk to interest rate risk.	Increase in NPLs of 30 percent or in the NPL/TL ratio of 3 percentage points.	Increase of 1 pet point/2pct points. Combination of weighted gap and duration methods.	Domestic currency depreciates by 15 or 20 percent.		Yes, two scenarios	Yes	Yes
Denmark	6 Nordic groups and 46 (out of 99) Danish institutions.	The banking institutions have increased their resilience considerably.	Increase in losses on loans to non-public sector of 1 or 2.25 percentage points.	Increase in interest rates of 1 or 3 pet points. Decrease in the average lending rate of 1 pet point.		Decrease in stock prices of 30%). Decrease in net fee and commission income of 40%o.	Yes, several combinations of the shocks listed here.	No	No
Germany	A sample of banks; insurance companies	No risk to financial stability at present.	Credit risk estimated by an econometric model.	Twists of the yield curve at the short end, parallel shifts across all maturities, and fluctuations in the medium-term range.	EUR appreciates or depreciates by 15%.	30%o decline in stock prices in all markets.	Yes, “oil price No scenario,” “int. rate scenario.” Credit risk scenario using an econo-metric model.	No	No
Hungary 2)	All active banks	Results indicate an improvement in the sectors’ resilience.	4 shocks to NPLs (e.g., doubling, increase of 2 std. dev.)	Domestic rates: +500 bps, -300 bps Foreign: +/-200 bps	+/- 40%	No	No	No	No
Latvia	All banks	Vulnerability to overall credit risk decreased in 2004; household lending the biggest risk.	Increase in NPL ratio of 3 percentage points. A number of sectoral shocks, assuming that a percentage of loans to some sectors become NPLs.	No explicit stress test included; the report notes that most loans are floating rate.	USD depreciating by 10% against EUR.		No	No	No
Poland	All banks	The system exhibits high stability.	Three shocks: (i) satisfactory and special mention loans migrate to doubtful; (ii) substandard and doubtful migrate to loss; and (iii) bankruptcy of three largest borrowers.	Not a stress test, but an analysis of gains/losses on interest-sensitive instruments, and the maturity of debt securities.	Not a stress test, but an analysis of VaR and open positions.	Equity price risk and property market risks analyzed (but without a stress test)		No	No
Netherlands 1)	Major fin. institutions (84% banks, 54% insurance, 50%) pension)	Banks are sufficiently shock-resistant.	+/-50 bps change in credit spreads (larger for insurance and pensions)	+/-100 bps parallel move; 50 bps flattening/steepening of yield curves (larger for insurance and pension)	+/-10% change in the exchange rate of EUR vs. other currencies	+/-15% change in all relevant stock indices; 25%> increase in market volatilities	Yes, “domestic crisis of confidence,” “dollar crisis”	No	Yes
Norway	All banks/seven largest conglomerates.	Short-term stability outlook satisfactory. However, increased vulnerability of household sector.	Decline in economic growth, increased unemployment.	Interest rates unchanged, but interest burden of real sector increased appreciably.		A fall in property prices reduces mortgage values, causing a rise in loss given default.	Yes, all tied to credit risk.	No	No
Sweden	Four major banks	The major banks have improved their potential for coping with shocks.	Failure of the largest counterparty, assumed recovery ratio of 25 percent.	Increase in interest rates of 1 pet point, and 30 percent fall in the stock market.			No	No	Yes

Source: Cihak and Hermanek (2005), based on central banks’ recent financial stability reports. Austrian National Bank: Financial Stability Report 7, June 2004. Danmarks Nationalbank: Financial Stability 2003. Deutsche Bundesbank: Report on the Stability of the German Financial System, Monthly Report, October 2004. De Nederlandsche Bank: Overview of Financial Stability in the Netherlands, December 2004, Issue No. 1. Hungarian National Bank: Report on Financial Stability, June 2003. National Bank of Poland: Financial Stability Review, First Half of 2004. Norges Bank: Financial Stability, 2004:1, June 2004. Sveriges Riksbank: Financial Stability Report, 2004:2.1)The latest FSR contained the stress tests carried out by (or in collaboration with) an FSAP mission.2)Based on end-2003 FSR. The subsequent two FSRs present only the “stress CAR,” which shows a bank’s financial position in a situation where all NPLs are written off.