Background to the EBA bank stress tests

Today, 15 July 2011, the European Banking Authority (EBA) published the results of the second round of stress tests. The first round was conducted in 2010 by the EBA’s predecessor, the Committee of European Banking Supervisors (CEBS). The tests assessed the resilience of European banks to adverse market developments and tested their solvency levels under hypothetical stress events.

This background article aims to give you more information about the tests and ING’s inclusion in them.

1. Did ING pass the stress tests?

Yes. The results show that ING Bank, like last year, comfortably passed this year’s more demanding stress test. Under the adverse stress test scenario, the estimated consolidated core Tier 1 capital ratio of ING would decline to 8.7% in 2012 compared to 9.6% as at the end of 2010. This is well above the benchmark set by the EBA of 5%. The test confirms the strong capital position of the Bank which makes us better equipped to absorb adverse shocks. The steps taken by ING to strengthen its capital position have also resulted in reduced balance sheet volatility.

2. Why was ING included in the stress test exercises?

ING was selected to participate in the tests because the EBA stipulates that at least 50% of the banking sector of each EU member state should be included in the test exercise. ING is one of the largest banks in the Netherlands.

3. Why are these tests necessary?

The stress tests were created by the European Banking Authority (EBA) in response to the financial crisis. They simulate how European Union banks would cope if economic conditions took a sharp turn for the worse, including the possible effects of a worsening of the sovereign debt crisis affecting some Eurozone countries. The aim of the tests is to identify which banks may need to raise capital to ensure they are strong enough to withstand a hypothetical adverse scenario.

4. Can you provide some background about the tests?

The exercise tests for stress on solvency (capital buffer levels), and do not test for liquidity stress. More specifically, they measure the impact of hypothetical shocks on profit and loss, loan loss provisions, credit risk exposures, exposures to sovereign debt and ultimately the capital adequacy of 90 banks in the European Union.

The stress test exercise pertains to ING Bank only; our Insurance operations are excluded. It is a scenario analysis, , based on EBA parameters that does not reflect any ING-endorsed forecast or expectation of the bank’s future performance.

5. So what are these specific tests?

The tests measure bank resilience under two scenarios: a baseline scenario and an adverse scenario. The baseline scenario assumes short-term interest rates in the euro area increase gradually to 1.5% and 1.8% in 2011 and 2012. Long-term interest rates are assumed to be 2.5% in 2010, 2.7% in 2011 and 2.9% in 2012; the gradual slight increase reflecting the global increase in risk pricing for financial assets.

The adverse scenario is composed of three elements: a set of EU shocks – mostly tied to the persistence of the ongoing sovereign debt crisis, a global shock on demand originating in the US and a depreciation in the US dollar relative to all currencies.

The exercises are based on the balance sheet as of December 31, 2010 as the reference point to test the impact of two years of adverse market conditions in 2011 and 2012.

6. When were the test exercises conducted?

Between March and June 2011.

7. How does this year’s stress tests differ from last year’s?

The adverse scenario this year includes a specific sovereign debt stress in the EU leading to further falls in the price of some EU bonds from the already stressed levels seen at the end of 2010. It also contains a marked deterioration in the main macro-economic indicators, such as GDP (which falls four percentage points from the baseline compared to three in the 2010 exercise), unemployment, and house prices. The stress tests this year focus on core Tier 1 capital which is more restrictive than the Tier 1 capital definition used last year.