## Iceland: Financial Sector Assessment Program—Technical Note on Stress Testing and Systemic Risk Analysis

_IMF Staff Country Reports, July 28, 2023_

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## Bibliographic details
- Published: July 28, 2023
- Series: IMF Staff Country Reports
- DOI: https://doi.org/10.5089/9798400251306.002

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### Overview
- Focus: Stress Testing and Systemic Risk Analysis for Iceland.
- Context: Assessment conducted against a background of a strengthened financial sector in Iceland amid heightened uncertainty in the global economy.
- Structural change: The Icelandic financial landscape has undergone significant structural transformation since the global financial crisis with a contracted banking sector.
- Main vulnerability identified: Foreign exchange (FX) funding remains a vulnerability despite overall soundness of the banking sector.

### Key findings from stress testing
- Scenario-based bank solvency stress test:
  - Confirmed the sector’s resilience to severe but plausible macro-financial shocks, with gross domestic product influence similar to the Global Financial Crisis.
  - The adverse scenario produced a significant impact on bank capital ratios, but no bank saw its capital ratios falling below the hurdle rates.
  - Resilience attributed to high initial capital positions and adequate pre-provision income.
- Liquidity Coverage Ratio (LCR)-based stress test:
  - Suggests the banking system on aggregate is broadly resilient to adverse liquidity conditions.
  - Not immune to additional liquidity outflows from pension and nonresident FX funding.

### Vulnerabilities and transmission channels
- FX funding:
  - Identified as a persistent vulnerability for the banking sector.
  - Potential channel for liquidity stress, particularly through nonresident FX funding.
- Pension sector:
  - Additional liquidity outflows from pension funds could materially affect bank liquidity positions.
- Capital and income buffers:
  - High initial capital positions and adequate pre-provision income provided significant resilience under the adverse scenario.

### Policy implications and recommendations (implied by findings)
- Maintain strong capital positions and monitor pre-provision income to preserve solvency buffers under severe shocks.
- Strengthen monitoring and management of FX funding exposures to mitigate liquidity risks stemming from nonresident FX funding.
- Assess and plan for potential liquidity linkages with the pension sector to prevent adverse spillovers to bank liquidity.
- Continue regular scenario-based stress testing (solvency and liquidity) to evaluate resilience against severe but plausible macro-financial shocks.

### Publication and metadata
- Publication title: Iceland: Financial Sector Assessment Program-Technical Note on Stress Testing and Systemic Risk Analysis
- Publication date: July 28, 2023
- Pages: 119
- Volume: 2023
- Issue: 276
- Series: Country Report No. 2023/276
- DOI: https://doi.org/10.5089/9798400251306.002
- Stock No: 1ISLEA2023003
- ISBN: 9798400251306
- ISSN: 1934-7685
- Subjects: Asset and liability management, Commercial banks, Expenditure, Financial institutions, Financial sector policy and analysis, Foreign exchange, International organization, Liquidity, Monetary policy, Pension spending, Stress testing
- Keywords: bank asset composition, bank liquidity position, Bank-NBFI network, Commercial banks, Europe, fair value, Global, interest rate projection, Liquidity, Pension spending, sensitivity analysis, stress test, Stress testing, Tier 1, top-down solvency stress test

*IMF Staff Country Reports 2023/276 (July 28, 2023), 119 pages, DOI: https://doi.org/10.5089/9798400251306.002*

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_Source: https://www.imf.org/en/publications/cr/issues/2023/07/26/iceland-financial-sector-assessment-program-technical-note-on-stress-testing-and-systemic-537013_