You may think of the stress tests as an exam that assesses a bank’s capabilities to face different macroeconomic scenarios. The EBA looks at the bank’s behaviour and the money it needs to continue functioning normally under certain stressful circumstances – hence the name “stress test.”
The exam was carried out based on the year-end 2015 figures of the banks. There are two scenarios – a baseline and an adverse scenario – and they cover the period from 2015 to 2018.This year, the adverse scenario, developed by the European Systemic Risk Board in Frankfurt, exposed banks to recessions in the EU in 2016 and 2017. The results of the exam give an indication of the banks’ capabilities to absorb losses and continue generating profit; in other words a clue as to how viable the tested banks are in this adverse economic scenario.
Once the banks receive the scenarios, they need to gauge the latters’ impact on their income, their credit and market risk positions, even their operational risk, over the three-year period in order to assess their solvency in these scenarios. Basically, they need to figure out if they could survive them. Of course, this is done following strict guidelines and under the watchful eye of the authorities.