The second* key pillar in the ECB’s Comprehensive Bank Assessment is a stress test, following the Asset Quality Review (AQR), which is discussed in Part 3 of this series. On 29 April, the European Banking Authority (EBA) released the stress test methodology and scenarios.
EBA faced a difficult choice in calibrating this EU-wide stress test: if they implemented a strict and credible test they risked imposing politically costly capital demands on EU banks; on the other hand, if they implemented too weak a test they would further damage the already blemished reputation of EU banking sector stress tests and (as a commentator has pointedly put it) “look like pointless clowns in the bargain”.
Now the choice has been made and the 2014 stress test scenario is available for commenting. However, as I have pointed out earlier when analyzing the 2011 EU-wide bank stress test results, the scenario may not even be the main issue. How it is being translated into the conclusions at the end, is just as if not more crucial. Therefore – and as other observers mostly focus on the scenario – I’ll explore the Methodological Note first.