Financial Fridays with Julie Pratten – Stress Testing for Banks

Friday 13 March 2015

by Julie Pratten

Welcome to Financial Fridays, your bi-weekly helping of buzz words and hot topics from the world of banking and finance, plus some ideas for activities that can be used as warmers, fillers or full-blown lessons. This week’s feature is on Stress Testing for Banks. In the aftermath of a series of crises, new methods have been adopted by the BIS to try and identify problem banks before they get into serious trouble.

If you have any requests or questions about any particular aspect of banking and finance, we would love to hear from you, so please feel free to post them.

This Financial Friday features:

• BANKING BUZZ – a handful of banking buzzwords. Why not send us your favourites­?

• FINANCIAL FOCUS – Stress Tests for Banks

• BLUE CHIP LINKS – suggestions for reading/listening material on our featured topic

 

Banking Buzz

Select the correct answer, A or B?

1 bullet loan

A a loan which is payable in full at maturity

B a loan provided by a moneylender with very high interest rates

2 the Old Lady

A a nickname given to the Euro

B a nickname for the Bank of England

3 burn rate

a selling junk bonds below their face value

b a kind of negative cash flow

4 panel bank

A the group of banks contributing to the Euro Interbank Offer Rate (EURIBOR)

B a bank that lends money to its own shareholders

5 narrow money

A the minimum amount of capital banks should hold by law

B funds that are immediately available, such as physical money and coins

 

Stress Tests for Banks

We are all susceptible to stress and in recent years even banks have become sufferers. Bank stress is a disease which last year hit the heart of the economies of several European countries and is still at epidemic levels. With a view to tackling fragilities in the banking sector, financial authorities such as the European Banking Authority (EBA) devised a series of stress tests for banks. The aim of these tests is to assess the ability of financial institutions to withstand adverse market developments, as well as to contribute to the assessment of systemic risk in the EU financial system.

 

1 Check your understanding

Complete the notes below.

To deal with weaknesses in the financial world, the leading authorities ……………………………………………………………………………………………

The two main aims of the stress tests

1…………………………………………………………………………………………..

2 ………………………………………………………………………………………….

 

2 Check the facts

Now read this short text about the test procedure and decide if the statements below are True or False.

The Procedure

The EBA conducted the bank stress test in European Union member states and Norway in the first half of 2011 in cooperation with national supervisory authorities, the European Central Bank (ECB) and the European Systemic Risk Board (ESRB). 91 banks participated from 21 countries, which represents around  50% of the total assets of each respective national banking sector or 65% of the assets of the entire European banking system.

In recent years, due to the confidence-starved market environment, there has been mounting pressure on banks to create transparency about their resilience to shocks such as a serious economic downturn, a decline in asset values or a rise in country risk.The aim of publishing detailed results of the stress test was to improve this atmosphere of uncertainty; however, it is important to note that the bank stress test is based on hypothetical scenarios, that is, ‘what if x happens?

1 The stress test was undertaken in 2011 by various Central Banks in EU countries and Norway.

2. The ECB hopes that stress tests will help to restore the lack of confidence in banks.

3. Nowadays banks are urged to improve transparency on their soundness in the case of financial turbulence.

4. One of the limitations of the stress tests is that they are only based on assumed scenarios.

 

3 Vocabulary focus; synonyms

Match the words in bold in the text with similar words or expressions below.

limit   absorb   highlights  adverse expectations   BIS Tier Capital Requirement   failed   decline  sound  have adequate funds   showed  reported   passed   adopted  validate

GERMANY All 12 German banks that participated in last year’s bank stress test conducted by the European Banking Authority (EBA) (1) managed to make the grade.

The banks achieved the minimum core tier 1 capital ratio of 5.0% in the adverse scenario required to pass the bank stress test. This EBA requirement is well above the current minimum (2) supervisory ratio applicable in Europe.

Sabine Lautenschläger, Vice-President of the Bundesbank (3) commented: “The results of the bank stress test show that the German banks in the sample (4) are sufficiently capitalised in the adverse scenario, and their capitalisation is also robust under these (5) pessimistic assumptions.

On a similar note, head of banking supervision at BaFin Raimund Röseler (6) pointed out the positive stress test outcome (7) underscores successful efforts (8) implemented by many banks last year to fortify their capital base.

ITALY The five Italian banking groups that participated in the EU stress test achieved the (9) threshold of 5 per cent; banks involved represent more than 62 per cent of the total assets of the Italian banking system. Results (10) endorse the adequacy of Italian banks’ capital to (11) mop up the shocks coming from further (12) deterioration of macroeonomic and market conditions.

However, the banks’ health check was not (13) rosy in all of the EU member countries. Five banks in Spain, two in Greece and one in Austria (14) flunked the test.

 

4 Review

Complete the sentences, using words and expressions from the texts. The first letter is given.

1 German banks p…………………… in the European bank stress test demonstrated their r…………………… even though the stress scenario was more severe than in 2010.

2 Most Italian banks a……………………….. the required core tier 1 capital r……………of at least 5.0%.

3 The aim of such tests is to a…………. the robustness of financial institutions to a……………… market developments.

4 Critics of the health check say that it fails to reflect market e……………………………… that some EU countries will default on their debt. Another problem is that the stress tests are merely h……………………………………, so they only represent fictional scenarios,

 

Answer key

Banking Buzz 1 A, 2 B, 3 A, 4 A, 5 B; Ex 2; True, 2 False, 3 True, 4 True; Ex 3; 1 passed, 2 reported, 3 BIS Tier Capital Requirement, 4 have adequate funds, 5 adverse expectations, 6 showed, 7 highlights, 8 adopted, 9 limit, 10 validate, 11 absorb, 12 decline, 13 sound, 14 failed; Ex 4; 1 participating, resilience, 2 achieved, ratio, 3 assess, adverse, 4 expectations, hypothetical;

Sources

http://www.euractiv.com:

http://www.bancaditalia.it/stress_test2011;internal&action=_setlanguage.action?LANGUAGE=en

 

Blue Chip links

Check out the following reading/listening material on the topic of bank stress tests.

Reading

http://www.bloomberg.com/news/articles/2014-12-16/rbs-lloyds-barely-pass-u-k-stress-tests-as-co-op-bank-fails

http://www.thisismoney.co.uk/money/markets/article-2808565/Britain-s-biggest-banks-pass-EU-stress-tests-Victory-UK-regulators-24-European-lenders-flunk-health-checks.html

http://www.ibtimes.com/federal-reserve-stress-test-2015-two-foreign-banks-fail-fed-exams-while-us-banks-1844122

Listening

http://www.bbc.com/news/business-29782902

http://www.dw.de/deutsche-bank-fails-us-stress-test/a-18309245

 

Copyright Julie Pratten 2015
Copyright this edition Delta Publishing 2015

One response to Financial Fridays with Julie Pratten – Stress Testing for Banks

  1. Sophie Rome says:

    This book has very thought-provoking topics (Fraud, Occupy Banking,Transparency and Accountability to name a few). The lead in questions at the start of each unit really help set the scene and generate discussions even if the learners aren’t familiar with the topic.
    My students find the articles interesting and there are some good activities for meetings and presentations. This is the first ELT book I have come across that addresses issues arising from the global banking crisis. It will challenge bankers to think about taking responsibility for their actions. All in all, an excellent book. I highly recommend it.

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