4.8 Application of stress testing programmes

As part of ICAAP and ILAAP, institutions should ensure that they have enough capital and liquidity resources to cover for the risks that institutions are, or might be, exposed to, and ensure the appropriate allocation of capital and liquidity resources across the entities of an institution over the economic cycle. This assessment should be reflected in the capital and liquidity plans that institutions should submit to the competent authorities as part of their ICAAP and ILAAP information and as part of the group risk assessment and liquidity profiles.

Furthermore, by means of stress testing, institutions should evaluate the reliability of their capital plans under stress conditions to ensure that they meet the capital requirements applicable to them. Any evaluation of capital plan reliability under stressed conditions should take into consideration scenario severity and occurrence probability. Institutions should also test the reliability of their liquidity plans to ensure that they can meet liabilities as they fall due under stress conditions. Institutions should assess the level of transferability of capital and liquidity resources in stressed conditions and consider any possible impediments, including legal, organisational and operational impediments. Institutions should, where appropriate, recognise that certain elements of capital requirements, as well as the liquidity buffers, may be used in stressed conditions (e.g. elements of the combined buffer requirements as specified in Chapter 4 of Title VII of Directive 2013/36/EU).

In addition to the general requirements related to institutions’ stress testing programmes specified in these guidelines, stress tests used for ICAAP/ILAAP purposes should meet the following specific requirements:

• a) institutions should cover all material risk categories (and sub-categories) that the institutions are exposed to with regard to both on- and off-balance-sheet assets and liabilities in relation to all material portfolios or sectors/geographies, including relevant structured entities;
• b) a range of scenarios should be considered including at least an adverse economic scenario that is severe but plausible, such as a severe economic downturn and/or a market-wide and idiosyncratic shock to liquidity;
• c) ICAAP and ILAAP stress testing should be performed through comprehensive institution-wide stress testing and reflect all entities for which ICAAPs or ILAAPs are required;
• d) ICAAP and ILAAP stress tests should cover the same forward-looking period as the institution’s ICAAP and ILAAP, respectively, and be updated at least as regularly as the ICAAP and ILAAP; ICAAP stress tests should cover a period of at least two years.

ICAAP and ILAAP stress tests should be consistent with the risk appetite and overall strategy (i.e. including the business strategy) of the institution. Institutions should demonstrate a clear link between their risk appetite, their business strategy, and their ICAAP and ILAAP stress tests. In particular, institutions should assess their capital and liquidity plans, and any internal capital planning, including management capital buffers, consistent with their stated risk appetite and strategy, and overall internal capital needs, and rebuild their liquidity positions after using liquidity buffers to meet their liabilities during a stress period.

Furthermore, in their ICAAP stress test, institutions should assess their ability to stay above applicable regulatory and supervisory capital requirements (e.g. total SREP capital requirements-TSCR) in stressed conditions.

When doing solvency stress tests for the purposes of ICAAP, institutions should also consider the impact of scenarios on the institution’s leverage ratio as well as eligible liabilities held for the purposes of minimum requirements for eligible liabilities (MREL).

Supervisory stress testing conducted pursuant to Article 100 of Directive 2013/36/EU or the scenarios or assumptions prescribed to an institution as a result of supervisory challenges and assessments of institutions’ own stress tests should not be seen as replacing the obligations of institutions to carry out stress tests as part of their ICAAPs and ILAAPs.

4.8.2 Management actions

Institutions should identify credible management actions addressing the outputs of stress tests and aimed at ensuring their ongoing solvency through the stressed scenario.

Institutions should consider a broad range of management actions (including within the liquidity contingency plans) against a range of plausible stressed conditions with a focus on at least one severe but plausible scenario.

To assess possible responses to a stressed situation, institutions should identify the credible actions that are most relevant and when they would have to take them. Institutions should take into account that some management actions are required immediately and others are contingent on specific events happening, in which case clearly defined triggers for action should be identified beforehand. Management actions should be consistent with stated strategies and policies, for example in the context of stated dividend⁸ policies. Institutions should be conservative about their ability to take mitigating management actions, recognising the possible impact of the stressed scenarios on other markets.

⁸ For example, see Article 141 CRD (maximum distributable amount).

Institutions should explain the qualitative and quantitative impacts of the stress before and after mitigating management actions. The impact before management actions should include assumptions about strategy, growth and associated revenue, but exclude management actions that would not be available in a stress event such as winding down a business line or raising capital.

Acceptable management actions will be subject to the guidance and judgement of competent authorities, and might include the following:

• a) the review of internal risk appetite and risk limits;
• b) the review of the use of risk mitigation techniques;
• c) the revision of policies, such as those that relate to liquidity and funding or capital adequacy;
• d) the reduction of distributions to shareholders;
• e) the changes in the overall strategy and business plan and risk appetite; and
• f) the raising of capital or funding.

Anticipated management actions differentiated by scenario and adjusted to the severity of the scenario should be documented. Institutions should take into consideration the reduction of the efficiency as a consequence of extremely severe stress situations. In the ICAAP and ILAAP information they must provide to the competent authorities, institutions should also explain management actions already taken based on the results of stress tests.