EBA kicks off 2021 EU-wide stress test exercise
How would Europe’s banks fare under seriously adverse conditions – for example if the Covid-19 pandemic is prolonged? We’re set to find out; on 29 January the European Banking Authority (EBA) launched the 2021 EU-wide stress test, and released the macroeconomic scenarios for the test.
In 2020 the exercise was postponed due to Covid, making it even more essential to analyse the resilience of the region’s banking sector now. Stress tests set out a set of assumptions or scenarios about adverse environments for regulated entities. Sometimes those scenarios seem highly unlikely, but this year’s version is likely already in the minds of most institutions.
Based on concerns about imminent risks, the EBA’s “adverse scenario” assumes an evolving, extended pandemic in a ‘lower for longer’ interest rate environment, in which a strong drop in confidence would prolong a heightened economic contraction. Its effects would include reductions in GDP and corporate earnings, increased unemployment, abrupt adjustments in financial asset valuations, and drops in real estate prices.
The EBA will assess the impacts of the scenario on banks’ solvency, and whether their capital reserves are sufficient to cover losses and support the economy. The stress test will involve a large sample of 50 banks, covering 70% of total banking assets in the EU. The EBA anticipates publishing the results by 31 July 2021. They could be used to inform decisions about exit strategies from the flexibility measures granted to banks for the duration of the pandemic, or alternatively on additional measures should the Covid crisis worsen. We have no doubt that other policy makers around the world will be taking careful note.
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