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Evaluation of Bank of England's Stress Testing Program
04/24/2019The Independent Evaluation Office (the Bank of England's independent review body) has published its evaluation of the BoE's approach to concurrent stress testing of the U.K. banking system. It concluded that overall the BoE has delivered on its stated approach and that the tests are valued highly by policymakers. The IEO has, however, outlined opportunities for refinement in three key areas, which the BoE has confirmed it is committed to implementing.
In the wake of the global financial crisis, the BoE reviewed its stress testing policy for the U.K. banking system and in 2015 published its approach to "concurrent" stress testing (the practice of simultaneously testing the entire balance sheets of several banks) up to 2018. The BoE's approach includes two scenarios: the annual cyclical scenario, a countercyclical scenario in which the severity of the scenario increases as risks build, and the biennial exploratory scenario, probing risks not linked to the financial cycle.
The IEO's recommendations fall under three main themes:
Theme 1: Advancing macro and microprudential objectives by focusing on: (i) scenario design, including engaging supervisors at an early stage of the stress scenario design phase; (ii) adjustments for less severe scenarios; and (iii) further benefits which may be gleaned from stress testing, such as exploring variants of the stress scenario (e.g. different property price profiles or interest rate paths).
Theme 2: Delivering the annual cyclical scenario and biennial exploratory scenario more effectively through improvements to: (i) data collection; (ii) modelling of results; (iii) cross-BoE cooperation; and (iv) standardization of results and analysis.
Theme 3: Communicating stress test outcomes appropriately via: (i) improved internal communication within the BoE and to BoE Committees; (ii) strategic external disclosure; and (iii) private feedback to firms highlighting themes for improvement and using less formal channels to provide an early indication of emerging themes.
The BoE has published its response to the evaluation, detailing the manner in which it intends to implement each of the above suggestions. Proposed actions include:
Theme 1: Preparation in Q4 of each year (commencing in 2019) of a report to the Financial Policy Committee and Prudential Regulation Committee setting out supervisory input, as well as a qualitative review in 2019 of the bank's stress testing frameworks against the stress testing principles of the Basel Committee on Banking Supervision;
Theme 2: Establishment of an annual forum on stress testing with banks and key stakeholders to discuss stress testing processes and opportunities for improvement; updating the BoE "Approach to Stress Testing" document to include a compressed timetable for the annual cyclical scenario; and movement of all core data templates that must be submitted by banks to a stable format by 2020; and
Theme 3: Adoption of standard stress test results templates for presentation to the BoE Committees and maintenance of a record of the most material judgements in the annual cyclical scenario results, in each case commencing in 2019; establishment of principles for external disclosure by the FPC and PRC; and a focus on improvements in feedback to individual firms, including provision of more quantitative information on adjustments to banks' stress projections.
View the IEO's evaluation report.
View the BoE's response to the IEO evaluation report.
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