The European Banking Authority (EBA), together with the European Systemic Risk Board (ESRB), has initiated a 2018 European Union (EU)-wide stress test to assess the resilience of participating institutions – 48 banks, accounting for 70% of the EU banking sector assets. The stress test exercise covers two scenarios (Baseline and Adverse), spanning a period of three years.
Snapshot of the 2018 Adverse Scenario
The narrative of the 2018 Adverse Scenario covers four systemic risks, of which abrupt and sizeable repricing of risk premiums in global financial markets is the most significant risk. Changes in expectations of economic policies in major non-EU economies and increased volatility in global financial markets triggered outside the EU will unravel the scenario. This is expressed with sharp stock price shocks to the US (-41% in 2018) and widening of US treasury yields (by 235 bps in 2018).
The advanced economies are expected to witness a general upward shift and steepening of the yield curve. Unlike the financial sector, the real sector has received a milder hit for the US economy as compared to the EU region. The US financial markets will drive volatility, but the EU will feel a higher economic impact transmitted through trade and financial linkages with the rest of the world.