In order to assess the resilience of the domestic banking system to adverse shocks, we regularly perform banking system solvency and liquidity stress tests. Stress testing is widely applied by central banks and supervisory institutions to measure the potential impact of risks to the banking system.
Results obtained through stress testing are not forecasts. On the contrary, they represent an analysis of highly unlikely events, and the conclusions made are only tentative. The results should be interpreted with caution and with due regard to the assumptions made. The latest results of the stress tests are presented in the Financial Stability Review.
Bank solvency stress testing
The main purpose of macroeconomic stress testing conducted at the Bank of Lithuania is to measure the resilience of the Lithuanian banking system and its constituent banks to adverse economic shocks. As in many other central banks, testing is carried out using the so-called ‘top-down’ approach, i.e. rules, scenarios and modelling assumptions used when conducting such tests are uniform for all banks subject to this exercise.
Solvency stress testing is focused on the assessment of the bank credit loss and profitability under an adverse macroeconomic scenario. The stress testing exercise at the Bank of Lithuania consists of three main steps:
- Step 1 involves the construction of an adverse macroeconomic scenario, i.e. unfavourable development of key economic indicators, related to relevant albeit unlikely economic shocks. The scenario is developed using the macroeconomic projections for the development of the national economy, the statistical features of official macroeconomic indicators as well as expert assessment.
- Step 2 involves the application of econometric models, which help establish links between the dynamics of macroeconomic variables and the developments in a bank’s credit risk and profitability. These models are of two types: credit loss models and profitability models.
- Step 3 involves the aggregation of modelling results obtained in different building blocks into a single profit and loss account. Changes in bank capital and risk-weighted assets are assessed simultaneously. These variables define the resilience of both individual banks and the banking system as a whole.
- V. Butkus, L. Naruševičius ‘Macroeconomic stress testing of the Lithuanian banking system: solvency assessment’, Monetary Studies 2015, No 1, p. 74–92 (http://www.lb.lt/pinigu_studijos_2015_1).
Bank liquidity stress testing
The main purpose of liquidity stress testing conducted at the Bank of Lithuania is to measure the resilience of the domestic banks to unfavourable short-term liquidity shocks, i.e. to a sudden and sizeable decrease in banks’ financial resources. The exercise has a one-month horizon. Decrease in financial resources is modelled as a sudden drop in customers’ deposits or constraints on short-term borrowing from other credit institutions. Testing results are obtained from a sensitivity test, i.e. through the assessment of shock-induced changes in the assets and liabilities of each bank and the calculation of indicators reflecting the banks’ liquidity status.