## _wp1368 - 11. Example of Bottom-up Bank Solvency Stress Test Summary Template Provided to Authorities: U.K. FSAP Update

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### Introduction and role of IMF stress testing
- Purpose and limitations
  - Stress tests exposed shortcomings in detecting pre-crisis vulnerabilities and are valuable in restoring market confidence (example: SCAP, 2009).
  - Stress tests are not fail-safe, stand-alone diagnostics; limitations included:
    - Simulated shocks sometimes not sufficiently severe.
    - Inadequate techniques for complex instruments and second-round effects.
    - Data limitations and weaknesses in scenario design, including cursory treatment of certain risk types and insufficient focus on spillovers across system segments and borders.
  - IMF emphasizes prescriptive guidelines to ensure coverage and some uniformity for cross-country comparisons.
- Use and demand
  - Stress testing is central to IMF work: FSAP, GFSR, Article IV, and crisis program work; demand for technical assistance on stress testing has increased.
  - Since 2008, more than 50 banking-sector stress tests have been conducted in FSAPs; insurance sector stress tests since 2003 have been conducted in only 10 countries and pension funds in two countries.
  - Since the inception of the FSAP, approximately 140 country assessments have been conducted; solvency stress tests have been conducted in practically all instances in recent years.

### Framework for bank solvency stress testing
- Objective
  - Assess banking system soundness under adverse macroeconomic conditions and anticipate performance against a baseline under severe macrofinancial stress over short and medium term.
- Key requirements
  - Thorough understanding of the financial system and institutions, including business models and cross-border linkages.
  - Flexibility to apply across diverse systems and regulatory regimes (examples: Basel I, Basel II/III).
  - Trade-offs among scope, scenario design, and methodologies given staff/authority resources and time constraints.
- Applicability
  - Framework must support consistent assumptions/models and be adaptable across advanced, emerging, and low-income countries.

### Scope, coverage, and approach
- Coverage considerations
  - Stress testing approaches: top-down (TD) and bottom-up (BU).
  - Institutions covered, market shares, sources of earnings and exposures.
  - Source(s), granularity, timeliness, and reliability of data.
- Top-down (TD) and Bottom-up (BU)
  - TD tests:
    - Conducted by IMF staff or authorities (or both).
    - Use individual-bank data aggregated or aggregated portfolio data.
    - Apply a common macrofinancial environment and standardized behavioral assumptions.
  - BU tests:
    - Individual institutions run tests using internal risk models and data; IMF prescribes common macro shocks and selected standardized assumptions to isolate shock impacts.
  - IMF advocates conducting both BU and TD tests where possible for cross-validation; divergences arise from model design, scope, data, behavioral assumptions, and sensitivity modeling.
- Implementation sample and publication
  - Sample used in paper: 18 countries participating in FSAPs since FY 2010 drawn from S-25 and other G-20 countries.
  - Publication status: Eight of the 18 countries have published all details of their FSAP stress tests: United States, Germany, United Kingdom, Sweden, Japan, France, Spain and Australia.
  - Of the remaining 10 countries, all but one consented to inclusion of the full suite of information for this paper.

### Scenario design and risk horizon
- Risk horizon
  - Multi-period: 1-5 years commonly applied.
  - Surveillance stress tests typically capture medium-term effects; major country FSAPs typically apply a five-year risk horizon.
  - Exceptions: Spain applies a 2-year risk horizon to accommodate rapid restructuring (IMF, 2012b).
  - Majority of emerging market economies use risk horizons between 1–3 years (examples: Indonesia, China, Turkey, Mexico).
- Scenario construction approaches
  - Baseline: typically IMF World Economic Outlook projections.
  - Direct approach: hypothetical state of risk parameters under stress.
  - Indirect approach: adverse macroeconomic scenarios translated into financial stress parameters via satellite models, VARs, or statistical approaches.
  - Satellite model explanatory variables commonly include:
    - (i) macroeconomic variables: economic growth, unemployment, short- and long-term interest rates, inflation, exchange rates;
    - (ii) sectoral indicators: residential and commercial real estate prices, equity market conditions;
    - (iii) micro-level data: bank-specific credit growth, operational/financial leverage, funding gaps.
- Shock magnitudes and tail risks
  - Growth shocks often defined as standard deviations from long-term historical averages: usually one (mild adverse) and/or two (severe adverse) standard deviations.
  - Examples of SD usage:
    - SDs calculated over 50 years.
    - BU: 4 SD.
    - TD: 1 SD; 2 SD; 4 SD.
    - Example: Australian four standard deviation shock estimated over a 50-year period; two standard deviation shock for several EU countries calculated over a 30-year period.
  - Tail risk emphasis: U.K. FSAP estimated capital losses for a 0.1 percent probability event; FSA ascribed two percent probability to a two standard deviation shock and IMF’s model calculated capital losses at the 95th percentile of this scenario (calculation: 0.05 × 0.02 = 0.001).

### Risks and sensitivity analysis covered
- Key risks included across exercises
  - Credit risk is primary.
  - Other risks: sovereign risk, funding risk, exchange rate risk, market risk, interest rate risk, off-balance sheet items, contagion and concentration risk.
  - Banking and trading books: valuation losses in AfS and HtM portfolios as well as trading book considered; treatment varies by country.
  - Funding costs: explicit incorporation nascent in solvency simulations (examples: France, Germany, Sweden and the United Kingdom).
  - Cross-border exposures and spillovers: network and ring-fencing analyses; some BU exercises require banks to estimate footprint-country impacts (example: United Kingdom).
- Sensitivity and auxiliary tests
  - Sensitivity tests used to assess instantaneous shocks and individual risk factors; majority conducted sensitivity on market risk factors.
  - Network analysis and market-based approaches applied for contagion and spillover risks.

### Data, sample coverage, and consolidation
- Data sources and practices
  - Sources: audited financials, supervisory data, banks' own data, public data; cut-off typically end of last fiscal year.
  - Supervisory data provided in almost all major country FSAPs: in 17 out of 18 cases, supervisory authorities provided regulatory return data; in one instance staff relied wholly on public information.
  - Consolidation approaches:
    - About half of FSAPs used consolidated banking group data (examples: Australia, China, Brazil, France, Japan, Netherlands, Sweden, the United Kingdom and the United States).
    - Others used unconsolidated local entity data (examples: Germany, India, Luxembourg, Mexico, Russia, Spain and Turkey).
  - Use of market data: growing use in data-rich advanced economies for corroboration and benchmarking (IRB parameters, market risk, operational risk).
- Sample coverage
  - Market share coverage of banks included in major country stress tests has been 60 percent or more of total assets and up to 100 percent in six of the 18 major countries since 2010 (examples: Brazil, India, Indonesia, Japan, Luxembourg and Russia).
  - Where resources constrain sample size (especially BU), focus on obviously systemic institutions.

### Capital standards, RWA treatment, and hurdle rates
- Capital definition and metrics
  - Capital definitions usually follow local regulatory requirements; most major countries adopted Basel II; many in transition to Basel III.
  - Capital metrics include total capital, Tier 1 and core/common equity Tier 1 with associated Basel III hurdle rates where applicable.
  - Capital adequacy outputs: amount of recapitalization required (in domestic currency); total capital, Tier 1, core Tier 1; capital shortfalls; number and asset share of failed banks.
- Hurdle rates and buffers
  - Hurdle rates generally align with Basel II or Basel III transition schedules; some exercises include capital conservation buffer and G-SIB loss absorbency.
  - Examples:
    - One instance applied 2019 Basel III target for core Tier 1 as supplementary benchmark (example: Spain).
    - Some jurisdictions used current regulatory minimums (example: regulatory capital set at 10 percent).
- Risk-weighted assets (RWA)
  - RWA treatments varied:
    - RWA kept constant (examples: China, Japan and Mexico).
    - RWA weights kept constant but total RWA adjusted for credit growth and/or credit losses (examples: Russia, Saudi Arabia and Spain).
    - RWA weights change under stress due to changes in risk profile plus asset growth (examples: France, Germany, Japan, Luxembourg, Netherlands and the United Kingdom).
  - Operational and market risk RWA often assumed unchanged or change proportionally with credit RWA changes.
  - FSAPs typically assume asset structure remains the same during risk horizon (no strategic asset substitution unless legally binding).

### Methodologies and models
- Preferred components
  - Balance sheet module, portfolio model using market information, and spillover analysis (contagion and feedback effects).
- Satellite models and macro-financial linkages
  - Satellite models translate macro scenarios into credit losses and profit components; can be run at economy, sectoral, bank, or portfolio level.
  - Construction steps include choice of estimation method, selection of variables, iterative fitting and robustness checks.
- Model types and trade-offs
  - Accounting-based (balance sheet) approaches: widely applicable, produce regulatory variables; cornerstone of FSAP stress testing.
  - Market price-based models (SCCA, DiDe): derive systemic risk measures from market data; supplement accounting approaches where market data available.
  - Macrofinancial models: examine macro-financial links, can be implemented with accounting- and market-based models.
  - Trade-offs: more sophisticated models increase estimation uncertainty; simpler methods may be inadequate for highly interconnected systems.
- Cross-validation
  - When different approaches are used, results are cross-validated and differences reconciled; assumptions and caveats included in write-up.
- IMF model cataloguing and scorecard
  - IMF staff cataloguing models developed within the institution; Table 4 (scorecard) summarizes model-data fit across approaches.

### Behavioral assumptions and managerial controls
- Balance sheet and credit growth assumptions
  - Balance sheets: often assumed constant or growing with nominal GDP; major country FSAPs split almost evenly between these assumptions.
  - Credit growth: based on satellite models, empirical evidence, or expert judgment; banks under stress assumed to reduce lending consistent with nominal GDP changes.
- Dividend payout and strategic adjustments
  - Most major country FSAPs assume dividend payout is zero under stress; alternatives include Basel III-like conservation schedules or historical ratios.
  - Strategic changes and asset disposal: typically not considered except legally binding commitments; maturing exposures assumed replaced unless a sound basis for not doing so.

### Communication, presentation, and publication practices
- Presentation of outputs
  - Templates: standardized output templates for BU results provided to banks and authorities.
  - Aggregated results should be consistent with regulatory regimes, sufficiently granular (peer groups or institutions where possible), show dispersion measures (minimum, inter-quartile range: 25th, 50th, 75th percentiles) and maximum if not institution-level, show outcomes for each year of the risk horizon, and show capital shortfalls in absolute terms and as percentage of GDP and percentage of total sector assets under consideration.
  - Detail contributions of drivers (profitability, credit/trading losses, RWA); clarify assumptions and limitations.
- Uses and publication
  - Provide quantitative support for FSAP stability assessments and policy discussions.
  - Communication to public is critical and sensitive; objectives, definitions, assumptions, models and limitations usually documented in Technical Notes and/or supplementary FSSA information.
  - Aggregated results of FSAP stress tests always disclosed in reports (minimum: post-stress ratio(s) and amount(s) of capital shortfall); individual bank results rarely disclosed.
  - All countries in the sample published their FSSAs; almost all produced Technical Notes (exceptions: Australia and Spain where details described in FSSA appendices); only a few countries consented to publication of Technical Notes (examples: Germany, Sweden, the United Kingdom and the United States).

### Practical guidance and key operational observations
- Best-practice emphasis
  - Use both BU and TD approaches where feasible for cross-validation.
  - Clearly document data limitations and transparency constraints when supervisory data cannot be shared.
  - Design scenarios that incorporate severe, “extreme but plausible” shocks and address tail risks, complex instruments, second-round effects, and cross-border spillovers.
  - Ensure stress tests reflect country-specific structural features, banks’ business models, and cross-border linkages.
- Operational findings from FSAP experience
  - Around half of the FSAPs to the major countries since 2010 have run both BU and TD tests (examples: Australia, China, France, India, Indonesia, Japan, Mexico, Russia, Turkey and the United Kingdom).
  - TD tests execution modes:
    - Conducted by IMF team only (examples: Indonesia, Netherlands, Turkey, Saudi Arabia, Sweden, India and Australia).
    - Conducted by authorities only (examples: Luxembourg, Russia and Japan).
    - Conducted separately by both using different methods (examples: China, France, Mexico and the United Kingdom).
  - Example (U.K. FSAP Update): BU stress tests run by seven major U.K. banks with FSAP team and FSA; TD tests by Bank of England using RAMSI and by FSAP team using SCCA with IMF and FSA macroeconomic forecasts and satellite outputs from BoE.

### Concluding remarks and areas for enhancement
- Limitations and challenges
  - Surveillance stress tests are not fail-safe or stand-alone diagnostics.
  - Conceptual and practical challenges include diversity of business models, model estimation uncertainty, data quality constraints, scenario negotiation and political sensitivities, and increased complexity during crises.
- IMF efforts and future directions
  - Standardizing shock scenarios across countries where possible and nascent attempts to quantify scenario likelihoods.
  - Applying complementary accounting- and market price-based models and wider coverage of risks.
  - Ensuring more organized and cohesive presentation of assumptions and results.
- Areas for further enhancement
  - Integration between solvency and liquidity risks.
  - Spillover analysis within financial systems and across borders.
  - Incorporation of feedback loops between real economy and financial sector.
- Final observation
  - Perfect standardization across countries is unlikely and not always desirable; expert judgment and qualitative analysis remain indispensable. Well-designed stress tests retain value despite being more art than exact science.

*Source: IMF staff paper — _wp1368 - 11.   Example of Bottom-up Bank Solvency Stress Test Summary Template Provided to Authorities: U.K. FSAP Update_*

### References .............................................................................................................

### References

### Tables
- 1.     S-25 and Other G-20 Countries: Status of FSAPs since FY 2010 .....................................7
- 2.     A Framework for Macroprudential Bank Solvency Stress Testing .................................12
- 3.     Basel III Transition Schedule ...........................................................................................25
- 4.     Scorecard on Data and IMF Stress Test Models ..............................................................31
- 5.     Example of Stress Test Matrix (STeM) for Bank Solvency Risk: Spain FSAP  
        Update        ..............................................................................................................................41

### Figures
- 1.     Solvency Stress Testing Applications ................................................................................8
- 2.     Example of IMF Stress Testing Exercise: U.K. FSAP Update ........................................15
- 3.    Example of Macro Scenarios for Stress Testing: U.K. FSAP Update .............................19
- 4.     General Representation of Satellite Modeling in Bank Solvency Stress Testing ............27
- 5.     Example of Satellite Model Estimations for Bank Solvency Stress Testing: U.K. FSAP 
Update ..............................................................................................................................28
- 6.     Example of Application of Satellite Model Outputs to Top-down Bank Solvency Stress 
Test Models: U.K. FSAP Update .....................................................................................29
- 7.     Stress Test Models Developed by IMF Staff ...................................................................32
- 8.     Key Conceptual Differences in Loss Measurements between the Accounting-based and 
Market Price-based Approaches .......................................................................................34
- 9.    Example of Bottom-up Bank Solvency Stress Test Output Template Provided to Banks: 
U.K. FSAP Update ...........................................................................................................38
- 10.   Example of Bottom-up Bank Solvency Stress Test Output Template Provided to 
Authorities: U.K. FSAP Update .......................................................................................39

*Source: _wp1368 - References*

### 11.   Example of Bottom-up Bank Solvency Stress Test Summary Template Provided to

### 11.   Example of Bottom-up Bank Solvency Stress Test Summary Template Provided to Authorities: U.K. FSAP Update

### Introduction
- The global financial crisis exposed shortcomings of stress tests in detecting vulnerabilities during the lead-up period and highlighted their value in restoring market confidence (e.g., SCAP, 2009).
- Stress tests are not fail-safe, stand-alone diagnostic tools; limitations included:
  - Simulated shocks sometimes not sufficiently severe.
  - Inadequate techniques for complex instruments and second-round effects.
  - Data limitations and weaknesses in scenario design, including cursory treatment of certain risk types and insufficient focus on spillovers across system segments and borders.
- IMF staff has emphasized prescriptive guidelines to ensure coverage and some uniformity for cross-country comparisons.
- Stress testing is central to IMF work: FSAP, GFSR, Article IV, and crisis program work; demand for technical assistance on stress testing has increased.
- Since 2008, more than 50 banking-sector stress tests have been conducted in FSAPs; insurance sector stress tests since 2003 have been conducted in only 10 countries and pension funds in two countries.

### IMF stress testing in context
- Stress testing purpose categories: macroprudential, microprudential, and risk management (Figure 1 referenced).
- IMF surveillance stress tests are typically macroprudential, aimed at system-wide resilience to severe scenarios and tail risks; findings inform policy discussions rather than mandate management action by banks.
- Cooperation from country authorities is critical; Article VIII prevents IMF from compelling disclosure of confidential bank-by-bank data.
  - Consequence: IMF sometimes relies solely on publicly available data or on authorities running tests and sharing only aggregated results; transparency and limitations must be documented.
- Distinct objectives of stress testing:
  - Supervisory (microprudential) stress tests (e.g., CCAR) embedded in supervisory processes and may require management action.
  - Crisis stress testing (macroprudential with crisis-management objective) used to restore market confidence (e.g., SCAP 2009, CEBS/EBA 2009–2011, Ireland, Spain).
  - Internal risk management: banks’ own bottom-up stress tests; supervisors sometimes issue guidance (examples: Hong Kong, Singapore, United Kingdom).
- IMF has proposed “best practice” principles for macrofinancial stress testing (IMF, 2012a) covering institutional perimeter, shock channels, risks, market perspectives, and tail risks.

### A framework for bank solvency stress testing
- Objective: assess banking system soundness under adverse macroeconomic conditions; anticipate performance against a baseline under severe macrofinancial stress over short and medium term.
- Key requirements:
  - Thorough understanding of the financial system and institutions, including business models and cross-border linkages.
  - Flexibility to apply across diverse systems and regulatory regimes (e.g., Basel I, Basel II/III).
  - Trade-offs among scope, scenario design, and methodologies given staff/authority resources and time constraints.
- Applicability: FSAP framework must support consistent assumptions/models and be adaptable across advanced, emerging, and low-income countries.

### Scope: key considerations
- Coverage must capture:
  - Stress testing approaches (top-down, bottom-up).
  - Institutions covered, market shares, sources of earnings and exposures.
  - Source(s), granularity, timeliness, and reliability of data.
- IMF staff typically conduct FSAP stress tests in close collaboration with supervisory authorities; granular supervisory data may be made available under strict confidentiality.
- Since the inception of the FSAP, approximately 140 country assessments have been conducted; solvency stress tests have been conducted in practically all instances in recent years.

### Approach: top-down (TD) and bottom-up (BU)
- TD tests:
  - Conducted by IMF staff or authorities (or both).
  - Use individual-bank data aggregated or aggregated portfolio data.
  - Apply a common macrofinancial environment and standardized behavioral assumptions.
  - Can be standalone or complement BU exercises.
- BU tests:
  - Individual institutions run stress tests using their internal risk models and data.
  - IMF staff prescribes common macroeconomic shocks and selected standardized assumptions to isolate shock impacts.
- IMF advocates conducting both BU and TD tests where possible for cross-validation:
  - Reconciling BU and TD results is a learning process; divergences typically arise from differences in model design, scope, underlying data, behavioral assumptions, and sensitivity modeling.

### Implementation experience and coverage
- Sample used in this paper: 18 countries that participated in FSAPs since FY (fiscal year) 2010, drawn from:
  - The 30 jurisdictions comprising the top 25 most systemically important financial systems (“S-25”) plus the remaining five other G-20 countries not among the S-25 (referred to as “major countries”).
- Publication status:
  - Eight of the 18 countries have published all details of their FSAP stress tests: United States, Germany, United Kingdom, Sweden, Japan, France, Spain and Australia.
  - Of the remaining 10 countries, all but one consented to inclusion of the full suite of information for this paper.
- Table 1 (S-25 and Other G-20 Countries: Status of FSAPs since FY 2010) lists jurisdictions, grouping, and FY of FSAP activity for ranks 1–25 and selected G-20 others; examples preserved exactly as in source:
  - Rank 1: United Kingdom — S-25, G-20, G7 — FY2011
  - Rank 2: Germany — S-25, G-20, G7 — FY2011
  - Rank 3: United States — S-25, G-20, G7 — FY2010
  - Rank 4: France — S-25, G-20, G7 — FY2012
  - Rank 5: Japan — S-25, G-20, G7 — FY2012
  - Rank 6: Italy — S-25, G-20, G7 — FY2013 *
  - Rank 13: Australia — S-25, G-20 — FY2013
  - Additional entries include Hong Kong SAR, Brazil, Russian Federation, Korea, Austria, Luxembourg, Sweden, Singapore, Turkey, Mexico, China, Belgium, Canada, Spain, Netherlands, Switzerland, India, Ireland, Hong Kong SAR marked with FY or “- **” per table.
  - Note: The table includes footnotes: “* FSAPs currently in progress; stress tests are not conducted for the FY2013 European Union FSAP.” and “** FSAPs scheduled for completion in FY2014.” and notes on the IMF fiscal year definition: “The IMF’s fiscal year (FY) runs from May 1 the previous year to April 30 the current year.”

### Key analytical observations and operational guidance
- IMF staff continues to develop a comprehensive and robust bank solvency stress testing framework; liquidity stress testing development has intensified and will be covered in a forthcoming paper by the authors.
- The paper complements IMF (2012a) by:
  - Articulating the framework and demonstrating application of “best practice” principles in FSAPs.
  - Presenting a cross-country Stress Testing Matrix (STeM) to compare implementation across major-country FSAPs (Appendix I).
  - Providing guidance for authorities preparing for FSAPs and for readers developing stress testing frameworks.
- Practical advice emphasized:
  - Use both BU and TD approaches where feasible for cross-validation.
  - Clearly document data limitations and transparency constraints when supervisory data cannot be shared.
  - Design scenarios that incorporate severe, “extreme but plausible” shocks and address tail risks, complex instruments, second-round effects, and cross-border spillovers.
  - Ensure stress tests reflect country-specific structural features, banks’ business models, and cross-border linkages.

*Italic source attribution: IMF staff paper — _wp1368 - 11.   Example of Bottom-up Bank Solvency Stress Test Summary Template Provided to Authorities: U.K. FSAP Update_*

### 1.   Scope

### _wp1368 - 1.   Scope

### Approach
- Bottom-up (BU)
  - By individual banks.
- Top-down (TD)
  - By authorities; by IMF.
- Coverage
  - Institutions
    - Number of banks.
  - Market share
    - Percentage of banking sector assets.
- Data
  - Source
    - Banks' own, supervisory and public data.
  - Cut-off date
    - End of last fiscal year.
  - Reporting basis
    - Unconsolidated banking groups, domestic businesses only.

### Scenario design
- Risk horizon
  - Multi-period
    - 1-5 years.
  - Instantaneous
- Scenarios
  - Baseline
    - IMF World Economic Outlook projections.
  - Growth shocks
    - Double-dip recession and protracted slow growth.
- Risks
  - Key risk(s)
    - Credit risk.
  - Other risks covered in scenario analysis
    - Sovereign risk, funding risk, exchange rate risk.
  - Other tests/risks
    - Sensitivity analysis of credit and market risks; network analysis of spillover risk.
- Factors that management control
  - Balance sheet growth
    - Growth of balance sheet in line with nominal GDP.
  - Credit growth
    - Credit growth based on satellite model.
  - Dividend pay-out rule
    - Historical payout ratio.
  - Other business strategy considerations
    - No asset disposal allowed.
  - Other assumptions
    - Taxes
      - Uniform (local corporate income) tax rate.

### Regulatory capital standards
- Capital definition
  - Domestic
    - Local regulatory requirements.
  - International
    - Basel III transition.
- Capital adequacy
  - Metrics
    - Amount of recapitalization required (in domestic currency); total capital, Tier 1 and 
      core Tier 1. 
  - Hurdle rate(s)
    - In line with Basel III transition schedule.
  - Changes in RWA
    - RWA calculated using Basel II formula.

### Methodology
- Stress test model
  - Accounting-based
    - Balance sheet approach (e.g., Schmieder and others, 2011).
  - Market-price based
    - Systemic contingent claims analysis (Jobst and Gray, forthcoming).
- Modeling of macro-financial linkages
  - Satellite models
    - Econometric models for credit losses, income, credit growth, etc..

*Source: _wp1368 - 1.   Scope*

### 5.   Communica tion

### 5.   Communica tion

### Presentation of output
- Template(s): Standardized output template for individual BU results provided to banks and
- Publication Medium: Results published in FSSA; Technical Note published.
- Key point: Granular data can lead to differences in the projection of profits and losses—and consequently the impact on the capital ratios—for individual banks under the various scenarios.
- Practices:
  - Decision whether BU stress tests complement TD tests or TD tests are performed by country authorities or IMF staff (or jointly) is made on an ad-hoc, country-by-country basis; usually based on data and resource availability and authorities’ receptiveness.
  - Around half of the FSAPs to the major countries since 2010 have run both BU and TD tests (examples listed: Australia, China, France, India, Indonesia, Japan, Mexico, Russia, Turkey and the United Kingdom).
  - TD tests may be: conducted by the IMF team only (examples: Indonesia, Netherlands, Turkey, Saudi Arabia, Sweden, India and Australia); conducted by authorities only (examples: Luxembourg, Russia and Japan); or separately by both using different methods (examples: China, France, Mexico and the United Kingdom).
- Example (U.K. FSAP Update):
  - Both BU and TD solvency stress tests are conducted together with TD liquidity risk stress tests.
  - BU stress tests run by the seven major U.K. banks in close coordination with the FSAP team and the Financial Services Authority.
  - TD tests performed by the Bank of England (BoE) using RAMSI and by the FSAP team using SCCA, applying IMF and FSA macroeconomic forecasts and satellite model outputs from the BoE.

### Coverage
- Ideal: Include all institutions if data and resources permit; realistically include all systemically important institutions and second-tier banks potentially systemic; smaller at-risk institutions could be included.
- FSAP practice:
  - Typically focus on major commercial banks in jurisdiction.
  - Market share coverage of banks included in major country stress tests has been 60 percent or more of total assets and up to 100 percent in six of the 18 major countries since 2010 (examples: Brazil, India, Indonesia, Japan, Luxembourg and Russia).
  - Where resources constrain sample size (especially BU), focus on obviously systemic institutions.
- Identification of systemic banks:
  - Remains not clear-cut; selection of marginally systemic smaller institutions is difficult.
  - Definition of systemic bank remains largely ad hoc in IMF-related stress testing; BCBS methodology for G-SIBs and FSB guidelines for D-SIBs are positive steps.

### Data
- Importance: Timely, reliable, and sufficient data underpin robustness and credibility of stress test results.
- Data sources and availability:
  - FSAP stress tests utilize latest audited and supervisory data alongside latest macro projections; cut-off date determined accordingly.
  - In less forthcoming authority situations, IMF staff rely on publicly available bank data, which may be less granular.
  - Supervisory data have been provided in almost all major country FSAPs: in 17 out of 18 cases, supervisory authorities provided regulatory return data; in one instance staff relied wholly on public information.
- Consolidation approaches vary:
  - About half of FSAPs used consolidated banking group data (examples: Australia, China, Brazil, France, Japan, Netherlands, Sweden, the United Kingdom and the United States).
  - Others used unconsolidated local entity data (examples: Germany, India, Luxembourg, Mexico, Russia, Spain and Turkey).
  - Main focus of bilateral FSAPs typically on domestic banking system suggests use of local-consolidated data to avoid double counting; consolidated data may not capture ring-fencing by host countries.
- Use of market data:
  - Growing use of forward-looking market data in data-rich advanced economies for corroboration and benchmarking (IRB parameters, market risk, operational risk).
- Cautions:
  - Expert judgment is crucial supplement to quantitative approach.
  - FSAPs do not audit banks’ accounts; cannot corroborate reported data quality.
  - Concerns about loan misclassification and lender forbearance should be explicitly noted (examples: Spain and the United Kingdom).

### B. Scenario Design
- Risk horizon:
  - Surveillance stress tests should capture medium-term effects; major country FSAPs typically apply a five-year risk horizon.
  - Exceptions: Spain applies a 2-year risk horizon to accommodate rapid restructuring (IMF, 2012b).
  - Majority of emerging market economies use risk horizons between 1–3 years (examples: Indonesia, China, Turkey, Mexico).
- Stress scenarios: baseline then post-shock assessments relative to baseline.
  - Baseline typically IMF’s World Economic Outlook (WEO) projections.
  - Stress scenarios defined by historical simulation, hypothetical scenarios tied to vulnerabilities, or ad-hoc expert judgment.
- Two approaches to construct stress scenarios:
  - Direct approach: hypothetical state of risk parameters under stress affecting solvency conditions (used for ad-hoc scenarios or historical simulation).
  - Indirect approach: adverse macroeconomic scenarios translated into financial stress parameters via:
    - Estimation of economic and financial variables conditional on macro scenario using structural econometric models, VAR methods, or pure statistical approaches (Foglia, 2008).
    - Translation via “satellite” models linking macro shocks to pre-impairment profit, impairments and RWA.
  - Common explanatory variables for satellite models:
    - (i) macroeconomic variables: economic growth, unemployment, short- and long-term interest rates, inflation, exchange rates;
    - (ii) sectoral indicators: residential and commercial real estate prices, equity market conditions;
    - (iii) micro-level data: bank-specific credit growth, operational/financial leverage, funding gaps.
- Shock magnitudes and tail risks:
  - Growth shocks often defined as standard deviations from long-term historical averages: usually one (mild adverse) and/or two (severe adverse) standard deviations.
  - Example: Australian four standard deviation shock estimated over a 50-year period; two standard deviation shock for several EU countries calculated over a 30-year period.
  - About half the exercises include a prolonged slow growth scenario (examples: Australia, Brazil, China, Germany, Japan, Turkey, Sweden, the United Kingdom and the United States).
  - Tail risk emphasis: U.K. FSAP estimated capital losses for a 0.1 percent probability event; FSA ascribed two percent probability to a two standard deviation shock and IMF’s model calculated capital losses at the 95th percentile of this scenario (calculation: 0.05 × 0.02 = 0.001).
- Flexibility and limitations:
  - Prevailing macroeconomic environment should drive shock design; e.g., overheating incorporated into Turkey’s scenario; Spain’s one standard deviation shock reflects revised baseline and fiscal adjustment.
  - Weakness: difficulty in extending home-country shock scenarios to consistently quantify impacts in other countries where international banks operate—IMF staff sometimes relies on banks to estimate footprint-country scenarios in BU exercises, risking inconsistency.
- Sensitivity tests:
  - Used to assess instantaneous shocks and provide immediate impact of individual risk factors.
  - Applied where data are limited or to complement scenario analyses.
  - Majority of major country FSAPs conducted sensitivity analysis on market risk factors.

### Risk factors to include
- Expanded focus post-crisis to cover a broader set of risks beyond credit and market risk:
  - Exposures to sovereign and other previously low-default assets:
    - Sovereign exposures previously often treated as risk-free; recent FSAPs estimate potential asset price losses for such exposures.
    - Shocks to bank holdings of sovereign assets incorporated in S-25 EU countries and Japan; some applied same to bank debt portfolios.
  - Banking and trading books:
    - Stress tests now attempt to estimate valuation losses in AfS and HtM portfolios in banking book as well as trading book; treatment varies by country (examples: valuation haircuts applied to both portfolios in France, Japan, Netherlands, Sweden, UK; only to AfS in Russia and Spain).
  - Funding costs:
    - Explicit incorporation of rising funding costs into solvency simulations is nascent (examples: France, Germany, Sweden and the United Kingdom).
  - Off-balance sheet items:
    - Important to capture contingent liabilities (guarantees, commitments, derivatives), but data are often not readily available.
  - Cross-border exposures:
    - FSAPs have incorporated spillover risks via network and ring-fencing analyses; some BU exercises require banks to account for shocks in countries where they operate (example: United Kingdom).
- Impairment parameter modeling:
  - Credit losses simulated via PDs and LGDs; decision between through-the-cycle (TTC) and point-in-time (PIT) parameters matters.
  - PIT risk parameters desirable during stressed periods.
  - Challenge: availability of PD/LGD parameters across the tested universe; proxies (e.g., from loan loss provisions) may be necessary (Schmieder and others, 2011).

### Factors that management control (assumptions)
- Importance: Standardized prescriptions on strategic/behavioral adjustments ensure consistent and comparable surveillance stress test results, especially for BU tests.
- Main behavioral assumptions used in FSAPs:
  - Balance sheet growth:
    - Typically assume constant (growing with nominal GDP or rule) or static balance sheets; major country FSAPs split almost evenly between these assumptions.
  - Credit growth:
    - Assumptions based on models (examples: Brazil, Spain, Sweden), descriptive empirical evidence (example: Turkey), and expert judgment; banks under stress assumed to reduce lending consistent with nominal GDP changes.
  - Dividend payout:
    - Most major country FSAPs assume dividend payout is zero under stress.
    - Other assumptions include payouts based on Basel III capital conservation standards (example: Sweden) or historical ratios (examples: Brazil, France, Japan).
    - General rule: dividends assumed paid only by banks that satisfy all three measures of capital adequacy after provisions and transfers to statutory reserves.
  - Strategic changes and asset disposal:
    - Typically do not consider management-driven business changes or strategic disposals/acquisitions (except legally binding commitments); firms assumed to replace maturing exposures unless sound basis for not doing so (e.g., deleveraging in IMF program countries).
- Guidance: No single “best practice” for each assumption; conservatism and country relevance are emphasized. Detailed guidance provided as relevant.

### C. Capital Standards
- Core elements in capital assessment:
  - Definition of capital;
  - Calculation of capital adequacy: capital metric(s), hurdle rate(s), assumptions on RWA, data consolidation.
  - Post-stress estimation of required recapitalization if shortfalls arise.
  - Transparency: ideally disclose composition of capital definitions applicable and planned regulatory changes (Appendix III).
- Capital definitions in FSAPs:
  - Usually follow local regulatory requirements.
  - Basel I use rare among major countries (example: Indonesia and some U.S. groups).
  - Most major countries adopted Basel II; many in transition to Basel III.
  - Capital definitions used in FSAP stress tests:
    - Follow Basel II requirements (examples: Australia, India, Indonesia, Luxembourg, Netherlands, Turkey, Russia and the United States).
    - Change in line with Basel III transition schedule for jurisdictions moving to new regime (examples: Brazil, France, Japan, Spain and Sweden); some apply own national transitional schedules (examples: Brazil and Japan).
    - Use benchmark parameters from BCBS’ QIS-6 to simulate likely impact of reforms (examples: Germany and the United Kingdom, with additional interim capital regime for BU exercise).
    - Apply separate local regulatory capital definition (example: Mexico).
- Capital metrics and hurdle rates:
  - For Basel II jurisdictions: total regulatory capital used to determine hurdle rate.
  - For Basel III transition: metrics include total capital, Tier 1 capital, and core/common equity Tier 1 capital with associated Basel III hurdle rates (Table 3) or national requirements.
  - In some cases, hurdle rates include capital conservation buffer (examples: France and Japan) and loss absorbency for G-SIBs captured in one case (France).
  - In a few instances, hurdle rates set in line with existing regulatory standards (examples: Australia and Netherlands and the United Kingdom).
  - One instance applied 2019 Basel III target for core Tier 1 as supplementary benchmark for crisis credibility (example: Spain).
- RWA treatment across FSAPs:
  - RWA kept constant (examples: China, Japan and Mexico).
  - RWA weights kept constant but total RWA adjusted for credit growth and/or credit losses (approximate to Basel II Standardized Approach) (examples: Russia, Saudi Arabia and Spain).
  - RWA weights change under stress due to changes in risk profile plus asset growth (examples: France, Germany, Japan, Luxembourg, Netherlands and the United Kingdom); consistent with Basel II/2.5/III rules for risk weights.
  - RWA for operational and market risks often assumed unchanged or change proportionally with credit risk RWA changes.
  - FSAP stress tests typically assume asset structure remains the same during risk horizon (banks do not replace maturing loans with securities assigned lower risk-weights).

### D. Method
- Preferable comprehensive solvency stress testing components:
  - Balance sheet module;
  - Portfolio model utilizing market information;
  - Spillover analysis (contagion and feedback effects).
- Macroeconomic and satellite modelling:
  - Satellite models translate adverse macroeconomic conditions into credit losses and profit components (funding costs, non-interest income, trading income).
  - Satellite models run at economy, sectoral, individual bank, or portfolio level.
  - Construction steps:
    - (i) choice of estimation method;
    - (ii) selection of dependent and explanatory variables;
    - (iii) iterative model fitting and robustness checks.
  - Modeling types: time series, regression (OLS, logistic, panel), structural models.
  - Major country FSAPs typically rely on authorities’ satellite models; FSAP team may cross-validate with IMF satellite models in parallel TD tests.
  - Figures referenced: Figure 4 (general representation), Figure 5 (satellite estimation example), Figure 6 (application to TD models) from U.K. FSAP Update.
- Stress test models:
  - Deterministic framework: balance sheet-based, prudential accounting identities.
  - Stochastic framework: incorporates uncertainty using historical volatility and/or market information (portfolio-based models).
  - Trade-offs:
    - More sophisticated models increase estimation uncertainty.
    - Simpler methods may be inadequate for highly interconnected/complex sectors.
  - When different approaches are used, results are cross-validated and differences reconciled; assumptions and caveats included in write-up.
  - Shortcomings: existing FSAP stress tests do not adequately capture feedback effects beyond initial macro shocks; literature and implementation of models incorporating feedback effects remain limited.
- IMF model strands used:
  - Accounting-based (balance sheet) approach: longest history, applicable across countries, produces regulatory variables; remains cornerstone of FSAP stress testing.
  - Market price-based models: derive systemic risk measures from dependencies among risk factors; capture joint default risk and distributional approaches (VaR, Expected Shortfall); less directly linked to regulatory ratios; used to supplement accounting approaches where market data available (SCCA, DiDe used in Germany, Mexico, Spain, Sweden, UK, US).
  - Macrofinancial models: examine systemic risks from macro-financial links; can be implemented with both accounting- and market-based models; satellite models may be classified as macrofinancial.
- Model cataloguing: IMF staff cataloguing models developed within institution to improve transparency (Čihák and Ong, forthcoming).
- Data-model scorecard: Table 4 summarizes model-data fit across approaches (balance sheet, network, extreme-value, SCCA, satellite models, DiDe).

### E. Communication
- Presentation of outputs:
  - Results aimed at informing senior supervisors; must be presented accessibly, highlighting risks and vulnerabilities.
  - BU results often aggregated by authorities for confidentiality; meaningful presentation format essential.
  - Aggregated results should be:
    - consistent with local regulatory requirements and transitions (e.g., Basel III);
    - sufficiently granular to at least list individual institutions or peer groups (if confidentiality constrains listing by institution);
    - show dispersion measures (minimum, inter-quartile range: 25th, 50th, 75th percentiles) and maximum if not institution-level;
    - show outcomes for each year of risk horizon;
    - show amount of capital required where hurdle not met, in absolute terms and as percentage of GDP and percentage of total sector assets under consideration;
    - detail contributions of different drivers (profitability, credit/trading losses, RWA);
    - clarify assumptions and key limitations.
- Uses of findings:
  - Provide quantitative support for FSAP stability risk assessment by estimating impact of tail risks;
  - Facilitate policy discussions with authorities on risk mitigation and crisis preparedness.
- Publication:
  - Communication to public is critical and sensitive; avoid promoting false security or undue alarm.
  - Objectives, definitions, assumptions, models and limitations usually documented in Technical Notes and/or supplementary FSSA information; publication voluntary for authorities.
  - Mandatory summaries using STeM presented in FSSA to improve transparency and comparability (Table 5 example for Spain FSAP Update).
  - Aggregated results of FSAP stress tests always disclosed in reports (minimum: post-stress ratio(s) and amount(s) of capital shortfall); individual bank results rarely disclosed.
  - All countries in sample published their FSSAs; almost all produced Technical Notes (exceptions: Australia and Spain where details described in FSSA appendices); only a few countries consented to publication of Technical Notes (examples: Germany, Sweden, the United Kingdom and the United States).

### IV. CONCLUDING REMARKS
- Surveillance stress tests are not fail-safe or stand-alone diagnostics; challenges highlighted by pre-crisis FSAP performance.
- Conceptual and practical implementation challenges:
  - Diversity of institution business models and activities;
  - Model estimation uncertainty and assumptions that may not capture all risks;
  - Data availability and quality constraints;
  - Scenario negotiation and political sensitivities;
  - Increased complexity during crises.
- IMF efforts to address shortcomings include:
  - Standardizing shock scenarios across countries where possible and nascent attempts to quantify scenario likelihoods;
  - Applying more encompassing stress tests (complementary accounting- and market price-based models) and wider coverage of risks;
  - Ensuring more organized and cohesive presentation of assumptions and results.
- Areas for further enhancement:
  - Integration between solvency and liquidity risks;
  - Spillover analysis within financial systems and across borders;
  - Incorporation of feedback loops between real economy and financial sector.
- Final observation:
  - Perfect standardization across countries is unlikely and not always desirable; expert judgment and qualitative analysis remain indispensable. Well-designed stress tests retain value despite being more art than exact science.

*Source: _wp1368 - 5.   Communica tion (IMF internal chapter/section content as provided).*

### 2.5 SD.

### _wp1368 - 2.5 SD.

### Scenarios and shock magnitudes
- SDs calculated over 50 years.
- BU: 4 SD.
- TD: 1 SD; 2 SD; 4 SD.
- Slow growth scenario: entries (per country rows) include: No; Yes; Yes; No; Yes; No; No; Yes (persistent terms of trade shock); Yes.

### Risks and scenario coverage
- Key risk(s) (selected entries from table):
  - Credit risk.
  - BU and TD by authorities: Credit risk.
  - TD by IMF: Pre-tax profitability--forecast on macro variables.
  - Interest rate risk.
- Other risks covered in scenario analysis (selected examples):
  - Oil prices decline by 1 SD to historical average.
  - Sovereign risk, in both trading and banking books (CEBS model).
  - Funding risk.
  - TD by authorities: Market risk (VaR).
  - BU: Sovereign risk in trading book and AfS in banking book; risks from domestic and foreign loan exposures, equities, foreign securities, exchange rate.
  - BU and TD by IMF: AAA sovereign risk (trading book and AfS in banking book in scenario analysis; HtM in sensitivity analysis).
  - TD by authorities: AAA sovereign risk (all books).
  - Structural reduction of pre-impairment income.
  - Off-balance sheet items.
- Other tests/risks (selected):
  - Sensitivity tests: Credit and market risks.
  - Contagion and concentration risks: Riksbank network model.
  - Sensitivity analysis: Credit risk, including sectoral credit risk and concentration risk; interest rate and exchange rate risks; equity prices.
  - Macro stress test: Credit risk.
  - Network analysis: Interbank market.
  - TD by authorities: Systemic risk and contagion.
  - Spillover risk: Cross-border and domestic using network model and EDF correlation.
  - Funding risk (BU and TD by authorities).
  - Network analysis and market-based approach: Contagion and spillover risks.
  - Spillover risk: Network analysis and ring-fencing.
  - Sensitivity tests: Credit and market risks.

### Stress testing framework — factors that management control
- Balance sheet growth (selected country treatments):
  - Constant B/S: Growth of B/S in line with nominal GDP.
  - Deleveraging in adverse case.
  - Static (per CEBS).
  - In a sudden stop, exposure-at-default is frozen at end-2010 (actual) level and stress applied.
  - Assets grow as projected by CBR's macro-financial model.
  - BU: Constant B/S--growth of B/S in line with authorities' projections; TD: Static.
  - Static B/S but credit growth is based on satellite model and dividend payout is lower under stress.
- Dividend payout (selected treatments):
  - Banks assumed to not raise capital nor reduce dividends in anticipation of a future capital need. Banks expected to not pay out common stock dividends in adverse scenario.
  - Dividend rule: --5 percent annualized dividend rate for Troubled Asset Relief Program (TARP) preferred shares; --8 percent for other preferred shares (relative to an average of 5 percent over 1990–99); --15 percent for common equity (relative to an average of 22 percent over [text truncated in source]).
  - Zero payout ratio.
  - Dynamic payout ratio (Basel III-like, but more stringent).
  - Zero payout under stress; positive payout assumed during boom period.
  - BU: Banks' recent dividend policy (fixed amount across all scenarios).
  - Historical payout ratio (baseline); lower rate under stress (towards zero, respecting the minimum payout ratio for Brazil under certain circumstances).

### Capital standards — definitions, adequacy, and metrics
- Capital definition (selected):
  - Capital definition in line with Basel I/II.
  - Capital definition in line with Basel II.
  - Capital definition in line with Basel III schedule.
  - Changes in capital definition according to QIS-6.
  - Capital definition in line with Basel II (standardized approach).
  - Regulatory capital defined by supervisory authority.
  - BU and TD by authorities: Capital definition in line with Title I of Part Ten of CRR. TD by IMF: Capital definition in line with Basel III schedule.
- Capital adequacy metrics/output (selected):
  - Capital under stress (T1, T1 common capital).
  - Contingent liabilities as EL under stress (SCCA).
  - Capital under stress (total regulatory capital).
  - Capital shortfall.
  - EL under stress (SCCA).
  - Number of failed banks and their share in the system by assets.
  - Aggregated stressed capital ratios for 8 banks.
  - Aggregated outputs: total capital, T1, CET1; capital shortfall; EL under stress (CCA/SCCA).
- Hurdle rate(s) (selected):
  - Hurdle rates in line with Basel I/II.
  - Hurdle rates in line with Basel III schedule (plus quantitative analysis for additional capital buffers).
  - Hurdle rates in line with Basel III schedule (but CET1 ratio set at 4 percent).
  - Regulatory capital set at 10 percent.
  - Current regulatory minimum (total capital ratio of 10 percent).
  - Solvency under stress will be assessed in terms of all components of capital (total capital, T1, CET1, plus conservation buffer, and loss absorbency requirement for G-SIBs) for each year of the risk horizon.
- Changes in RWA (selected):
  - RWA path modeled statistically based on the ratio of RWA to total assets. (Under the baseline scenario, RWA/TA would return progressively back to 2000-05 average by mid-2011; under adverse scenarios, RWA/TA would remain stable at the low end-March 2010 levels).
  - RWA kept constant.
  - RWA calculated using Basel II formula.
  - RWA changes in line with QIS-6.
  - RWA grows with total assets; the write-off of defaulted loans is deducted.
  - RWA adjusted for credit growth and credit losses (statutory capital) and adjusted for risk (quasi-IRB computation).
  - BU and TD: Banks' modeling of RWA changes.
- Reporting basis (selected):
  - Capital adequacy determined on a group-wide consolidated basis.
  - Capital adequacy determined on an unconsolidated basis.
  - Capital adequacy determined based on unconsolidated local entities.

### Methodology and models
- General approaches:
  - Adverse scenario generated using a simple closed-economy business cycle model for the US, with standard monetary channels (Taylor rule and nominal rigidities) and fiscal channels (a fiscal rule and a link between the real interest rate and government debt).
  - Satellite models used in each pillar to map the macrovariables into the financial variables.
  - Losses estimated using country/authority-specific models: IMF/Bank Indonesia model; ECB elasticity model; Bundesbank model; BoE model; BoJ model; CBR model; SCCA (systemic contingent claims) used by IMF in several TD analyses.
- Main model (selected entries):
  - TD: Balance-sheet based; Distress Dependency; Systemic contingent claims.
  - BU: B/S.
  - TD: Dynamic panel model developed by IMF and Bank Indonesia.
  - TD by IMF: SCCA.
  - TD by authorities: BoE RAMSI.
  - BU: Banks' internal models or CBR's methodology for combined shocks.
  - TD: CBR's macro stress test model and combined shock test.
  - TD by IMF in collaboration with authorities: B/S.

### Communication and publication practices
- Publication (selected):
  - Technical Note, published.
  - Results discussed in FSSA, published.
  - Technical Note, not published.
  - Results discussed in FSSA, published; technical details included as appendix.
  - Technical Note, publication to be decided by authorities.
  - No Technical Note; Results discussed in FSSA; technical details included as appendix, published.

### Appendix II — Example: summary of key assumptions applied in solvency stress testing exercise: U.K. FSAP UPDATE
- Domain: Risk factors assessed (selected rules/assumptions)
  - Credit losses based on satellite models developed by firms depending on scenario.
  - Profit (interest income, interest expenses, net fee and commission income, and operating expenses) should be based on firm’s satellite models (or expert judgment). For end-2010, net profit before tax should be adjusted for extraordinary income/losses.
  - Trading income based on satellite model or statistical matching of both trading income and GDP growth using a parametric fit of their historical distribution.
  - Funding costs based on satellite model for interest expenses, including a non-linear effect. Changes in funding costs due to different solvency conditions cannot be smaller than the one generated by either some general funding cost sensitivity or results from suggested CCA-based approach (Appendix III, Option 2). These changes are unaffected by possible balance sheet deleveraging.
  - Mark-to-market impact on fixed income holdings: Focuses on the projection of haircuts for holdings of both sovereign and bank debt based on IMF approach. These haircuts will be applied to both trading and banking book.
  - Sovereign and financial sector debt holdings: Haircut on holdings in the banking and trading books based on market expectations over five years after controlling for changes of market valuation during 2010 as developed by IMF staff. Exclusions: Cash at central banks, repos and asset swaps where there is no economic interest in the security. Haircuts applied only to issuers that are non-“AAA” rated.
  - FX shock: Firms report marginal impact of FX shock for U.S. dollar, euro and Japanese yen. The shock for each currency should be twice the standard deviation of the respective FX volatility during 2010 and impact the trading book in 2011 (100 percent) and 2012 (50 percent) only.
  - Tax assumption: 25 percent in case of positive profits, zero otherwise.
- Behavioral adjustment of banks (selected rules/assumptions)
  - Balance sheets are assumed to be constant and to grow in line with nominal GDP.
  - Dividend payout depends on capitalization under stress: dividend pay-out only if firm reports profits over the past year; if total capital ratio is above 8.0 percent (after the envisaged dividend payout and, at the same time, exhibits sufficient Tier 1 and common equity Tier 1 capitalization) but below the 10.5 percent threshold (which reflects the magnitude of the proposed “capital conservation buffer” under Basel III), the firm is considered capital-constrained and needs to follow a defined payout schedule.
  - Credit growth in line with nominal GDP for banks with a Tier 1 capital buffer of 2.5 percentage points above the regulatory minimum (i.e., hurdle rate); credit growth decreases by 2 percentage points for each decrease in Tier 1 capital by 1 percentage point once the capital buffer is less than 2.5 percentage points above the Tier 1 capital hurdle rate. Hence, growth becomes negative when capitalization is at the minimum capital ratio unless nominal GDP grows by more than 5 percent.
  - Other business strategy considerations: Asset disposals or acquisitions over time should not be considered, except where legally binding commitments under EU state aid rules exist. Maturing exposures are assumed to be replaced. Any interim capital-raising until end-2010 can be considered in calculations.

### Appendix III — Example comparison table on relevant core Tier 1 capital definitions: U.K. FSAP UPDATE (selected elements)
- Core Tier 1 components (Basel II, Basel III, EBA, FSA General Prudential Sourcebook, FSA Interim Capital Regime/ FSAP Bottom-Up Stress Testing):
  - Ordinary shares.
  - Retained earnings and reserves.
  - Share premium account (relating to CT1 instruments where applicable).
  - Minority Interests (subject to limits or as specified).
  - Externally verified interim net profits included in several treatments.
  - Existing government support measures counted as CT1 in some entries.
- Core Tier 1 filters and deductions (selected):
  - Filters include pension deficit net of deficit reduction amount (if DRA approach chosen); unrealized gains on AfS equities; unrealized gains on Investment property; unrealized gains on land and buildings; unrealized losses (gains) on AfS debt.
  - Deductions include interim net losses; intangibles including goodwill; investments in own shares; shortfall of the stock of provisions to expected losses (50 percent shortfall in some frameworks); deferred tax assets (limited recognition allowed); reciprocal cross holdings in the common stock of banking, financial and insurance entities; significant investments in the common stock of banking, financial and insurance entities outside the scope of regulatory consolidation (limited recognition).
  - Additional specific deductions referenced: 50 percent of certain securitization exposures; 50 percent material holdings in financial institutions (excluding material insurance holdings); 50 percent free deliveries.

*Source: IMF (2011a).*

### REFERENCES

### _wp1368 - REFERENCES

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- Basel Committee on Banking Supervision, 2009, “Principles for Sound Stress Testing Practices and Supervision,” BCBS Publication No. 155, May (Basel: Bank for International Settlements), available at http://www.bis.org/publ/bcbs155.pdf.
- Basel Committee on Banking Supervision, 2010a, “Results of the Comprehensive Quantitative Impact Study,” BCBS Publication No. 186, December (Basel: Bank for International Settlements), available at http://www.bis.org/publ/bcbs186.htm.
- Basel Committee on Banking Supervision, 2010b, “Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems,” BCBS Publication No. 189, December (Basel: Bank for International Settlements), available at http://www.bis.org/publ/bcbs189.htm.
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### IMF, FSAP, and country-level stress testing technical notes
- International Monetary Fund, 2010a, “Integrating Stability Assessments under the Financial Sector Assessment Program into Article IV Surveillance,” IMF Policy Paper (Washington, August), available at http://www.imf.org/external/np/pp/eng/2010/082710.pdf and http://www.imf.org/external/np/pp/eng/2010/082710b.pdf.
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- International Monetary Fund, 2010c, “United States: Publication of Financial Sector Assessment Program Documentation—Technical Note on Stress Testing,” IMF Country Report No. 10/244 (Washington, July), available at http://www.imf.org/external/pubs/ft/scr/2010/cr10244.pdf.
- International Monetary Fund, 2011a, “United Kingdom FSAP Update: Stress Testing the Banking Sector Technical Note,” IMF Country Report No. 11/227 (Washington, July), available at http://www.imf.org/external/pubs/ft/scr/2011/cr11227.pdf.
- International Monetary Fund, 2011b, “United Kingdom: Financial System Stability Assessment,” IMF Country Report No. 11/222 (Washington, July), available at http://www.imf.org/external/pubs/ft/scr/2011/cr11222.pdf.
- International Monetary Fund, 2011c, “Sweden: Financial Sector Assessment Program UpdateTechnical Note on Contingent Claims Analysis Approach to Measure Risk and Stress Test the Swedish Banking Sector,” IMF Country Report 11/286 (Washington, September), available at http://www.imf.org/external/pubs/ft/scr/2011/cr11286.pdf.
- International Monetary Fund, 2011d, “Germany: Technical Note on Stress Testing,” IMF Country Report No. 11/371, (Washington, December), available at http://www.imf.org/external/pubs/ft/scr/2011/cr11371.pdf.
- International Monetary Fund, 2012a, “Macrofinancial Stress Testing: Principles and Practices,” IMF Policy Paper (Washington, August), available at www.imf.org/external/np/pp/eng/2012/082212.pdf.
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- Moretti, Marina, Stolz, Stéphanie, and Mark Swinburne, 2008, “Stress Testing at the IMF,” IMF Working Paper No. 08/206 (Washington: International Monetary Fund), available at http://www.imf.org/external/pubs/ft/wp/2008/wp08206.pdf.

### Working papers, methodologies, and academic studies on stress testing and systemic risk
- Bernanke, Ben S., 2010, “The Supervisory Capital Assessment Program―One Year Later,” Speech delivered at the 46th Annual Conference on Bank Structure and Competition, Federal Reserve Bank of Chicago, (Chicago, May), available at http://www.federalreserve.gov/newsevents/speech/bernanke20100506a.htm.
- Borio, Claudio, Drehmann, Mathias, and Kostas Tsatsaronis, 2012, “Stress-testing Macro Stress Testing: Does It Live Up to Expectations?” BIS Working Paper No. 369, January (Basel: Bank for International Settlements), available at http://www.bis.org/publ/work369.htm.
- Cerutti, Eugenio, and Christian Schmieder, 2012, “The Need for “Un-consolidating” Consolidated Banks' Stress Tests,” IMF Working Paper No. 12/288 (Washington: International Monetary Fund), available at http://www.imf.org/external/pubs/ft/wp/2012/wp12288.pdf.
- Chan-Lau, Jorge, Srobona Mitra and Li Lian Ong, 2012, Identifying Contagion Risk in the International Banking System: An Extreme Value Theory Approach,” International Journal of Finance and Economics.
- Čihák, Martin, 2007, “Introduction to Applied Stress Testing,” IMF Working Paper No. 07/59 (Washington, D.C.: International Monetary Fund), available at http://www.imf.org/external/pubs/ft/wp/2007/wp0759.pdf.
- Čihák, Martin, and Li Lian Ong (eds.), forthcoming, An IMF Guide to Stress Testing (Washington: International Monetary Fund).
- Drehmann, Mathias, 2009, “Macroeconomic Stress-testing Banks: A Survey of Methodologies,” in Mario Quagliariello (ed.), Stress Testing the Banking System: Methodologies and Applications (New York: Cambridge University Press).
- Espinosa-Vega, Marco A. and Juan Solé, 2011, “Cross-border Financial Surveillance: A Network Perspective,” Journal of Financial Economic Policy, Vol. 3, No. 33, pp. 182–205.
- Fell, John, 2006, “Overview of Stress Testing Methodologies: From Micro to Macro,” Presentation to the Korea Financial Supervisory Commission/Financial Supervisory Service-International Monetary Fund Seminar on Macroprudential Supervision Conference on Challenges for Financial Supervisors (Seoul, November), available at http://www.imf.org/external/np/seminars/eng/2006/macropr/pdf/Fell.pdf.
- Foglia, Antonella, 2008, “Stress Testing Credit Risk: A Survey of Authorities’ Approaches,” Occasional Paper No. 37, December (Rome: Banca d’Italia).
- Gray, Dale F., and Andreas A. Jobst, 2011, “Modelling Systemic Financial Sector and Sovereign Risk,” Sveriges Riksbank Economic Review, No. 2, pp. 68-106, available at http://www.riksbank.se/upload/Rapporter/2011/POV_2/er_2011_2.pdf.
- Gray, Dale F., Jobst, Andreas A., and Samuel Malone, 2010, “Quantifying Systemic Risk and Reconceptualizing the Role of Finance for Economic Growth,” Journal of Investment Management, Vol. 8, No.2, pp. 90–110.
- Howard, Stacia, 2008, “Stress Testing with Incomplete Data: A Practical Guide,” Proceedings of the IFC Conference on Measuring Financial Innovation and Its Impact (Basel, August), available at www.bis.org/ifc/publ/ifcb31.htm.
- Jobst, Andreas A., Hardy, Daniel, and Christian Schmieder, forthcoming, “Sovereign Haircuts,” IMF Working Paper (Washington: International Monetary Fund).
- Jobst, Andreas A., and Dale F. Gray, 2013, “Systemic Contingent Claims Analysis— Estimating Market-Implied Systemic Solvency Risk,” IMF Working Paper No. 13/54 (Washington: International Monetary Fund), available at http://www.imf.org/external/pubs/ft/wp/2013/wp1354.pdf.
- Ong, Li Lian, Maino, Rodolfo, and Nombulelo Duma, 2010, “Into the Great Unknown: Stress Testing with Weak Data,” IMF Working Paper No. 10/282 (Washington: International Monetary Fund), available at http://www.imf.org/external/pubs/ft/wp/2010/wp10282.pdf.
- Schmieder, Christian, Puhr, Claus and Maher Hasan, 2011, “Second Generation Applied Stress Testing—Solvency Module,” IMF Working Paper No. 11/83 (Washington: International Monetary Fund), available at http://www.imf.org/external/pubs/ft/wp/2011/wp1183.pdf.
- Segoviano, Miguel and Pablo Padilla, 2006, “Portfolio Credit Risk and Macroeconomic Shocks: Applications to Stress Testing under Data-Restricted Environments,” IMF Working Paper No. 06/283 (Washington: International Monetary Fund), available at http://www.imf.org/external/pubs/ft/wp/2006/wp06283.pdf.
- Vitek, Francis, and Tamim Bayoumi, 2011, “Spillovers from the Euro Area Sovereign Debt Crisis: A Macroeconometric Model Based Analysis,” CEPR Discussion Paper No. 8497 (London: Centre for Economic Policy Research), available at http://www.cepr.org/pubs/dps/DP8497.asp.

### Institutional reports and national exercises
- Banco de España, 2012, “Bank Recapitalization and Restructuring Process: Results of the Independent Evaluation of the Spanish Sector,” (Madrid, September), available at http://www.bde.es/bde/en/secciones/prensa/infointeres/reestructuracion/valoracionesind/.
- Central Bank of Ireland, 2011, The Financial Measures Programme Report (Dublin, March), available at http://www.centralbank.ie/regulation/industry-sectors/credit-institutions/documents/the financial measures programme report.pdf.
- Financial Services Authority (FSA), 2011, Prudential Risk Outlook, March (London: Financial Services Authority), available at http://www.fsa.gov.uk/pages/library/corporate/pro/index.shtml.
- Financial Stability Board (FSB), 2011, “Policy Measures to Address Systemically Important Financial Institutions” (Basel, November), available at http://www.financialstabilityboard.org/publications/r_111104bb.pdf.
- Financial Stability Board (FSB), 2012, “Extending the G-SIFI Framework to Domestic Systemically Important Banks,” Progress Report to the G-20 Finance Ministers and Central Bank Governors (Basel, April 16), available at http://www.financialstabilityboard.org/publications/r_120420b.pdf.
- Ingves, Stefan, 2013, “From Ideas to Implementation,” Remarks at the 8th High Level Meeting organized by the BCBS and the Financial Stability Institute (Cape Town, January 24), available at http://www.bis.org/review/r130124a.pdf.
- Banco de España, 2012, “Bank Recapitalization and Restructuring Process: Results of the Independent Evaluation of the Spanish Sector,” (Madrid, September), available at http://www.bde.es/bde/en/secciones/prensa/infointeres/reestructuracion/valoracionesind/.

*Content derived from _wp1368 - REFERENCES*

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