To assess the resilience of banks operating in Lithuania to adverse shocks, we periodically perform solvency and liquidity stress tests of the banking sector.
Bank solvency stress testing
The main purpose of bank solvency stress testing conducted by the Bank of Lithuania is to assess the capital adequacy of the Lithuanian banking sector and its constituent banks to adverse economic events.
During the stress testing, economic development scenarios covering a three-year period are constructed. The baseline scenario is based on the most recent macroeconomic development projections published by the Bank of Lithuania and is used to assess the sustainability of banks under normal, expected economic developments. Taking into account the risks relevant to the Lithuanian economy and financial system at the time, unlikely but plausible adverse scenarios are also constructed. These scenarios model an economic downturn or shocks and are therefore used to assess the resilience of banks under adverse conditions.
The stress testing reveals how various bank performance indicators would change under each of the constructed scenarios. Changes in the capital adequacy ratio summarise the modelling results and show how individual banks and the banking sector as a whole respond to each scenario.
Read more about the bank solvency stress testing methodology used by the Bank of Lithuania here.
The latest solvency stress testing results are presented here.
Bank liquidity stress testing
The main purpose of bank liquidity stress testing conducted by the Bank of Lithuania is to assess the resilience of the domestic banks to adverse liquidity shocks. The Bank of Lithuania performs two liquidity stress testing exercises: a liquidity coverage ratio (LCR) test and a cash flow analysis.
The LCR test assesses the resilience of banks and credit unions to short-term liquidity shocks – their ability to meet liquidity needs over a 30-day period. The following three adverse liquidity shocks are applied in this exercise:
1. A decrease in the value of liquid assets;
2. A sudden increase in outgoing cash-flows, for example, higher-than-normal customer deposit withdrawals;
3. A decrease in incoming cash flows.
The results are obtained through the assessment of changes in the assets, liabilities and overall liquidity position of banks due to the adverse scenario.
The cash flow analysis assesses the ability of banks to manage net cash flows over a one-year period. During the stress testing, liquidity shock scenarios of different durations are applied to assess whether banks are not overly dependent on unstable sources of funding and have sufficient liquid asset buffers to meet their net cash flow liabilities under an adverse scenario.
Read more about the bank liquidity stress testing methodology used by the Bank of Lithuania here.
The latest liquidity stress testing results are presented here.
Sensitivity analysis of the banking sector to climate risk
Climate change and the factors associated with the transition to a climate-neutral economy could challenge the resilience of the financial system and eventually become a source of systemic risk. There are two main groups of risks associated with climate change:
• physical risk, which covers direct financial losses due to the impact of climate-related events on assets;
• transition risk, which covers losses that may arise because of the transition to a climate-neutral economy.
The level of physical risk attributed to Lithuania is one of the lowest among EU countries, while transition risk is significant due to high bank lending to the polluting manufacturing and transport sectors.
To better assess the potential impact of lending to polluting companies and changing macroeconomic conditions on financial stability, a sensitivity analysis of the Lithuanian banking sector was conducted in 2023. Three different scenarios of the green transition, developed by the Network for Greening the Financial System (NGFS), were used. The results of the analysis show that the financial losses from not taking additional policy measures are significantly larger than the losses associated with the transition to a climate-neutral economy.
Read more about the measures for managing climate-related risks to financial stability and the related stress testing scenarios here.