Sai Sireesh: Stress Testing – Measuring Systemic Risk Across the Globe

Last year, the European Union was exploring a Systemic Risk Council to better manage risks. A small, but significant step towards a consolidated EU Systemic Risk management is the recent round of Stress Tests in EU.

As we know, the American banks underwent a similar stress testing exercise early in 2009. Ten of 19 large US banks were required to raise a combined $75 billion in capital after the stress testing was completed.

On Friday, CEBS released stress tests results that subject each bank's Tier 1 capital projections until the end of 2011 to worst case scenarios. The tests were conducted on 91 banks across 20 countries. Only seven out of 91 banks in EU failed the tests. EU banks need a total of 3.5 billion euros (US $4.5 billion) to boost their capital reserves, compared to the fear it would be much higher. Given the diverse nature of EU states, there were different measures in different countries around some assumptions of the shock scenarios around recession, unemployment rates, property values, during economic and financial storm.  

A total of seven banks failed the tests including five small Spanish banks, Germany's state-rescued Hypo Real Estate and Greece's Atebank. There were 17 banks that met the borderline 6-6.9 % Tier 1 capital in the worst case scenario. There were 15 banks each on 7%-7.9% and 8%-8.9% range. There were 13 banks in 9% - 9.9%  ratios, and 24 banks with 10% or higher Tier 1 capital ratios.

Spain, of course, led the drive for transparency and conducted much wider tests of its banking system and more disclosures. Other major economies are exploring stress testing, too, in order to boost confidence, as well as systemic risk measures (e.g. Chinese regulators are expected to conduct industry-wide stress testing). Investors and analysts can also run their own risk simulations based on the detailed breakdown of the bank’s exposure to the sovereign debt of EU and other countries.

More power to high performance computing capabilities, essential for more stress and back testing to come!

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