Subject matter, scope and definitions

(1) Solvency stress test

means the assessment of the impact of certain developments, including macro- or microeconomic scenarios, on the overall capital position of an institution, including on its minimum or additional own funds requirements, by means of projecting the institution’s capital resources and requirements, highlighting the institution’s vulnerabilities and assessing its capacity to absorb losses and the impact on its solvency position.

(2) Liquidity stress test

means the assessment of the impact of certain developments, including macro- or microeconomic scenarios, from a funding and liquidity perspective and shocks on the overall liquidity position of an institution, including on its minimum or additional requirements.

(3) Bottom-up stress test

means a (solvency or liquidity) stress test with all of the following characteristics:

i. it is carried out by institutions using their own internally developed models;

ii. it is based on the institution’s own assumptions or scenarios, with possible conservative constrains by authorities;

iii. it is based on the institution’s own data and potentially high level of data granularity, with possible use of external data for some additional information; and

iv. it concerns particular portfolios or the institution as a whole, producing detailed results on the potential impact of exposure concentrations, institution linkages and contagion probabilities to the institution’s loss rates.

(4) Top-down stress test

means a (solvency or liquidity) stress test with all of the following characteristics:

i. it is carried out by competent authorities or macroprudential authorities;

ii. it is based on general or systemic (macroprudential) assumptions or scenarios designed by competent or macroprudential authorities and applicable to all relevant institutions;

iii. competent authorities or macroprudential authorities manage the process and calculate the results with less involvement of the institutions than in the case of the bottom-up stress test;

iv. it is based mostly on aggregate institution data and less detailed information, depending on the assumptions of the stress test, or sometimes based on more detailed institution data if deemed necessary by authorities; and

v. it enables a uniform and a common framework and comparative assessment of the impact of a given stress testing exercise across institutions.

(5) Static balance sheet assumption

means a methodological assumption according to which the impact of the stress test scenarios is to be measured on the assumption of a ‘constant balance sheet’ and of an ‘unchanged or stable business model’ throughout the projection period, enhancing the comparability of the results across institutions, thereby:

i. prohibiting from taking into account, for the calculation of the impact of the scenarios, changes in the assets and liabilities of the institution that derive, indicatively, from management actions, increases or work-outs of existing lending or differences in maturities or other characteristics of these assets or liabilities (despite the application of the stress test methodology, which might lead to changes in the size and the composition of the balance sheet, and particularly the capital base, over the projection period, due to, for example, new defaults, impairments, increases of stock or value adjustments of financial assets); and

ii. permitting the inclusion of new assets and liabilities as far as these new items bear the same main characteristics (maturities, risk profiles, etc.) with the excluded ones.

(6) Dynamic balance sheet assumption

means a methodological assumption according to which the impact of the stress test scenario is to be measured on the possibility of a non-constant balance sheet and of an evolving business model throughout the projection period. Under the dynamic balance sheet assumption, the outcome of the stress test reflects a combination of the scenario imposed and the responsive actions taken by the management reducing the comparability of the results across institutions. The extent of responsive actions taken by the management may be constrained or unconstrained (e.g. interventions planned from the start and independent from the scenario and/or conditional on the stress test scenario).

(7) Portfolio level stress test

means a stress test of individual or several portfolios with the focus on the implications of the shocks from a single risk factor or multiple risk factors.

(8) Sensitivity analysis

means a stress test that measures the potential impact of a specific single risk factor or simple multi-risk factors, affecting capital or liquidity, to a particular portfolio or to the institution as a whole.

(9) Scenario analysis

means the assessment of the resilience of an institution or of a portfolio to a given scenario that comprises a set of risk factors, which should have all of the following characteristics:

i. they are aligned in an internally consistent way;

ii. the risk factors forming the relevant set presuppose the simultaneous occurrence of forward-looking events covering a range of risks and business areas; and

iii. the set of risk factors also aim to reveal, to the maximum extent possible, the nature of linked risks across portfolios and across time, system-wide interactions and feedback effects.

(10) Reverse stress test

means an institution stress test that starts from the identification of the pre-defined outcome (e.g. points at which an institution business model becomes unviable, or at which the institution can be considered as failing or likely to fail in the meaning of Article 32 of Directive 2014/59/EU) and then explores scenarios and circumstances that might cause this to occur. Reverse stress testing should have one or more of the following characteristics:

i. it is used as a risk management tool aimed at increasing the institution’s awareness of its vulnerabilities by means of the institution explicitly identifying and assessing the scenarios (or a combination of scenarios) that result in a pre-defined outcome;

ii. the institution decides on the kind and timing (triggering events) of management or other actions necessary for both (a) rectifying business failures or other problems; and (b) aligning its risk appetite with the actual risks revealed by the reverse stress testing;

iii. specific reverse stress testing can be also applied in the context of recovery planning (e.g. reverse stress tests applied in a wider context can be used to inform a recovery plan stress test by identifying the conditions under which the recovery might need to be planned).

(11) Second-round or feedback effects

means the spillover effects (the nature of feedback effects is not limited to macroeconomic effects) caused by the responses of individual institutions to an external original shock, which – in aggregate – generally amplify (it may also mitigate) such an original shock, thereby causing an additional negative feedback loop.

(12) Severity of scenario

means the degree of severity of the assumptions or the deterioration of the scenario (from baseline to an adverse scenario) expressed in terms of the underlying macroeconomic and financial variables (or any other assumptions). The greater the severity of the scenario, in general, the larger the impact of the stress test on the institution, thereby determining the actual severity of the stress test.

(13) Plausibility of scenario

means the degree to which a scenario can be regarded as likely to materialise in respect of the consistency of the relationship of that scenario with the current macroeconomic and financial variables, the support of the scenario by a coherent narrative and the backing of the scenario by probability distribution and historical experiences. Plausibility is not restricted to historical experiences, and hence expert judgements that take into account changing risk environments (e.g. observed structural breaks) and stress events that were observed in similar risk environments outside the institution’s own direct historical experience should play a key role. It is also possible to use simulative methods (e.g. Monte Carlo simulations).

(14) Anchor scenario

means a type of scenario usually designed by a competent authority to set the severity standard for a particular stress test, which is imposed on institutions, either as the scenario that should be applied in the stress test or as a severity benchmark for the development of the institution’s own scenarios.

(15) Risk data aggregation

means defining, gathering and processing risk data according to the institution’s risk reporting requirements to enable the institution to measure its performance against its risk tolerance/appetite. This includes sorting, merging or breaking down sets of data.

(16) Data infrastructure

means physical and organisational structures and facilities to build and maintain data and information technology (IT) architecture to support the institution’s risk data aggregation and internal policy on risk reporting.