Briefing on the Bank of England Stress Test

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This presentation covers the development process used for creating fully expanded common baseline and stress scenarios, based on projections published by the Bank of England.

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  • Maintain extensive database of economic, financial, market and demographic data down to the regional and city level with over 250 million time series covering 200+ countries and 600+ cities sourced from the most relevant local sourcesProvide the highest frequency and most up-to-date data with monthly updated forecasts of national and regional economies worldwideForecast alternative macroeconomic scenarios (our own, regulator defined, customer requested) globally for stress testing and risk managementForecast and stress test clients’ credit portfolios with customized models through industry-leading modeling approach that combines completeness, pragmatism, transparency and accuracySupported by an experienced and focused team of subject matter experts:80+ economists/ credit modelers, more than 40% of which have PhD’s20+ data specialistsLocated around the globe in London, Prague, Sydney and West Chester
  • UK & US given by PRA (only UK on the website), EUZN by MACCAR – short market rate given by the Fed – upper bound on the policy rate.PRA – five years (start shifted from 2013q3 to 2014q1)
  • - UK & US given by PRA (only UK on the website), the rest by MA.
  • Mention FX in nominal terms.
  • Big pictureModelShocksScenario
  • Mention narratives.
  • Briefing on the Bank of England Stress Test

    1. 1. Briefing on the Bank of England Stress Test: Common & Bespoke Scenarios Dr. PETR ZEMCIK, DIRECTOR
    2. 2. 1 Introduction 2
    3. 3. 3 About Moody’s Analytics Leading global provider of credit rating opinions, insight, and tools for credit risk measurement and management Independent provider of credit rating opinions and related information for nearly 100 years Research, data, software, and related professional services for financial risk management Moody's Analytics operates independently of the credit ratings activities of Moody's Investors Service. We do not comment on credit ratings or potential rating changes, and no opinion or analysis you hear during this presentation can be assumed to reflect those of the ratings agency. 3
    4. 4. Economic & Consumer Credit Analytics – Our Services Forecasts with Alternative Scenarios Regulatory Stress Test Advisory Services Macro, Financial Data and Economic Research Consumer Credit Analytics Risk Management, Strategic Planning, Business and Investment Decisions 4
    5. 5. 5 Today’s Speaker Dr. Petr Zemcik, Director Chief European Economist Dr. Zemcik supervises a group of economists responsible for analysis, modeling, and forecasting for Europe. He holds a PhD and MA in Economics from the University of Pittsburgh and MSc in Econometrics and Operations Research from the University of Economics in Prague. 5
    6. 6. Agenda » » » » » » » » » Introduction Regulatory Scenarios Framework Interest Rates Paths Foreign Exchange Rates: Fundamentals & No Arbitrage Fed Taper 2014: FX & Yield Shock Output Projections: U.K. and Other Countries and Regions Extension to Other Variables Financial Models And Credit Risk Concluding Remarks 6
    7. 7. 7 Please send your questions to help@economy.com 7
    8. 8. 2 Regulatory Scenario Framework 8
    9. 9. Expected PRA 2014 Stress Test Timeline January 10 – Firms submit high-level risks to PRA* January 31 – PRA provides comments on risks explored by firms* February 24 – Firms submit worked-up scenario.* March 12 – banks submit detailed portfolio data up to yr-end 2013. March 31 – PRA baseline and stress scenarios published. April 4 – official submission of bespoke scenarios.* April 4 – MA completes forecasts for PRA baseline and stress Scenarios. April 9 – MA completes narratives for PRA baseline and stress Scenarios. April 30 – PRA board approves risks.* Q2 – banks analyse impact of scenarios. June 30 – results approved by each bank’s Board submitted to the PRA. Q2/Q3 – The BoE runs regulatory models and compares results with banks’ analysis. The BoE also conducts system-wide & feedback analysis. » Q4 – FPC/PRA Board decisions and disclosure. » » » » » » » » » » » » * Dates related to bespoke scenario development. 9
    10. 10. Regulatory and MA Stress Scenarios PRA Anchor Scenario 2013H2 - Dual banking and sovereign debt crisis. - High/low interest path FED CCAR 2013 Scenarios Adverse Scenario - High interest rates, low inflation - Motivated by the Great Recession, FED Taper Severely Adverse Scenario - Euro zone crisis, global recession MA Stress Scenarios Euro Zone Crisis (“S4”) - Dual banking and sovereign debt crisis, Grexit. Oil Price Shock (“S6”) - Stagflation, high interest rates 10
    11. 11. PRA/BoE & CCAR/Fed Scenarios in Numbers » PRA 2013H2 – Provided series: 14 U.K., 14 U.S., 2 Euro Zone – MA: 19 countries, 2 regional aggregates – Euro Zone and Asian-Pacific » CCAR 2013 – Provided series: 16 U.S., 3 EUZN, 3 DA, 3 U.K. – MA: 36 countries, 9 regional aggregates – Delivery in business days: U.S. 3 days, countries 4 days, regional aggregates 5 days – World, North America, South America, Developed Asia, Developing Asia, Europe, Euro Zone, Middle East and Africa, Oceania – 30 US CCAR banks. » MA Models/Capacity – – – – U.S. model 1600+ variables 55 country models, 60+ variables each Financial market and credit risk models Numerous satellite support models 11
    12. 12. Moody’s Analytics Country Model Design 10-yr yield Other deflators Wages and salaries Investment Exchange rates Government Labor force Exports Imports Import prices GDP Global GDP Employment Population Monetary policy rate Prices Consumption Unemployment rate Potential GDP Global prices 12
    13. 13. 3 Interest Rates Paths 13
    14. 14. Fundamentals Drive Interest Rates in Long-Run Variable Description Coef.1 Real 10-yr yields(fwrgt10yq.igbr-@pcy(fwcpiq.igbr)); R2=0.63, 1995Q4-2013q3 C constant @movav(@pcy(fwgdplq_igbr(-1)),3) Nominal GDP (Bill. GBP, SAAR) fwrmpolq.igbr-@pcy(fwcpiq.igbr) BoE discount rate (NSA), real @movav((fwggbblq_igbr/fwgdplq_igbr),4) Budget balance ratio to nominal GDP(SA) 0.72* - 0.09 0.84*** - 81.37*** Monetary policy rate (dlog(fwrmpolq.igbr)); R2=0.54, 1998Q2-2013q3 C constant - 0.09*** d(fwlbrq.igbr-fnairu.igbr) Unemployment gap (SA) - 0.39*** dlog(@movav(fwcpiq_igbr(),1)) 1 Consumer price index(2005=100, SA) 9.42*** With“***” the variable is significant at 1%, with ”**” at 5% and with “*” at 10% 14
    15. 15. Policy Rates and Yields Fitted vs. Actual U.K. rates, % 9 8 7 6 5 4 3 2 1 0 96Q1 Actual 10-yr bond yield Fitted 10-yr bond yield Actual policy rate Fitted policy rate 98Q3 01Q1 03Q3 06Q1 08Q3 11Q1 13Q3 Source: Moody’s Analytics 15
    16. 16. Assumptions for the PRA Policy Rates PRA policy rates, % 6 U.K. U.S. Euro zone 5 4 3 2 1 0 06Q1 08Q3 11Q1 13Q3 16Q1F 18Q3F 21Q1F 23Q3F Sources: ECB, BoE, Fed, Moody’s Analytics 16
    17. 17. Yields in the Low Path Anchor Scenario PRA 10-yr government bond yields, % 7 U.K. U.S. Euro zone Germany Italy 6 5 4 3 2 1 06Q1 08Q3 11Q1 13Q3 16Q1F 18Q3F 21Q1F 23Q3F Sources: ECB, BoE, Fed, IMF, Bank of Italy, Moody’s Analytics 17
    18. 18. NFC Loan Rate Determination PRA, U.K. rates, % 8 10-yr govt. bond yield 3-mo libor NFC loan rate 7 BoE policy rate 6 5 4 3 2 1 0 06Q1 08Q3 11Q1 13Q3 16Q1F 18Q3F 21Q1F 23Q3F Sources: BoE, BBA, ONS, Moody’s Analytics 18
    19. 19. 4 Exchange Rates: Fundamentals & No Arbitrage 19
    20. 20. Good Fit for GBP/USD Exchange Rate $ per £, log(fwtfxiusaq.igbr); R2=0.42, 1998Q1-2012Q3 2.1 Actual $ per £ Fitted $ per £ 2.0 1.9 1.8 1.7 1.6 1.5 1.4 96Q1 98Q3 01Q1 03Q3 06Q1 08Q3 11Q1 Variable Description Coef.1 C constant - 0.74*** log(fwcpiq.iusa/fwcpiq.igbr) U.S.- U.K. inflation gap 1.99*** log(fwrmpolq.igbr/fwrmpolq.iusa) 1 13Q3 U.K.- U.S. policy rate gap - 0.05*** With“***” the variable is significant at 1%, with ”**” at 5% and with “*” at 10% Source: Moody’s Analytics 20
    21. 21. Dollar Depreciates in the Anchor Scenario PRA exchange rates, 2013Q4=100 140 Pound per $ Euro per $ Yen per $ 130 120 110 100 90 80 08Q1 10Q3 13Q1 15Q3F 18Q1F 20Q3F 23Q1F Source: Moody’s Analytics 21
    22. 22. The Fed Sets Main Exchange Rates CCAR exchange rates, Severely Adverse Scenario, 2013Q3=100 130 Pound per $ Euro per $ Yen per $ 120 110 100 90 80 70 08Q1 10Q3 13Q1 15Q3F Source: Moody’s Analytics 22
    23. 23. 5 Fed Taper 2014: FX and Yield Shock 23
    24. 24. German Yields Decouple From the U.S. and U.K. 10-yr government bond yields, % 5.5 5.0 U.S. Germany 4.5 U.K. Fed tapering first mooted in May 13 4.0 3.5 3.0 Tapering confirmed to start Jan 14 2.5 2.0 1.5 1.0 Jan-08 Oct-08 Aug-09 Jun-10 Mar-11 Dec-11 Sep-12 Jun-13 Sources: Bloomberg, Moody’s Analytics 24
    25. 25. Fed Tapering Could Affect European Growth Real GDP growth in 2014 under alternative assumptions, % 3.0 Baseline Bond yield spike 100 bps Euro 10% depreciation Combined impact 2.5 2.0 1.5 1.0 0.5 0.0 Germany France Italy Spain Source: Moody’s Analytics 25
    26. 26. 6 Output Projections: U.K. and Other Countries and Regions 26
    27. 27. Challenges » GDP targets across countries and scenarios – Time series regressions – Severity » Decomposition of GDP into components » Aggregates (e.g. Euro zone) – Bottom-up approach – Targeting 27
    28. 28. Germany CCAR Target Estimation Variable Description Coef.1 German GDP (dlog(fwgdpl$q_ideu)); R2=0.84, 2000Q2- 2013Q2 C constant -0.0003 dlog(fgdp$_fedb.us) U.S. real GDP under Fed CCAR baseline (Bil. 2009 USD, SAAR) -0.013 dlog(fwgdpl$q_fedb.ieuzn) Euro zone real GDP under Fed CCAR baseline (Bil. 2005 EUR, SAAR) 1.312*** dlog(fwgdpl$q_fedb.igbr) U.K. real GDP under Fed CCAR baseline (Bil. 2009 GBP, SAAR) -0.249* dlog(fwgdpl$q_fedb.ijpn) Japan real GDP under Fed CCAR baseline (Bil. 2005 JPY, SAAR) 0.130* dlog(gdp_febd_asia) Developing Asia real GDP under Fed CCAR baseline ( Bil. 2009 USD, SAAR) 0.025 dlog(fwgdpl$q_ideu(-1)) Germany real GDP (Bil. 2005 EUR, SAAR) 0.030 1 With“***” the variable is significant at 1%, with ”**” at 5% and with “*” at 10% 28
    29. 29. Anchor Scenario Is the Most Severe U.S. U.K. Euro Zone PRA -4.6 -4.8 -5.2 CCAR Adverse CCAR Severely Adverse -0.4 -0.9 -1.6 -2.1 -3.7 -3.9 S4 -4.3 -4.4 -4.8 Start-to-trough, % Probability of a worse start-to-trough, % PRA 4.6 1.5 3.3 CCAR Adverse CCAR Severely Adverse 34.5 16 23.3 17 2.7 8.1 S4 5.5 1.6 4.4 29
    30. 30. Investment And Consumption in the U.K. Variable Description Coef.1 Real household consumption per capita (dlog((fwcl$q_igbr/fwpopq_igbr)); R2=0.56, 1995Q3-2012Q2 @movav(d(fwrgt10yq.igbr-@pcy(fwcpiq.igbr)),3) 10-year discount bond yield (NSA), real -0.003 pdl(dlog((fwypdlq.igbr()/(fwcpiq.igbr()*fwpopq. igbr()))),4,2,3) Real disposable income per capita (Bil. 2005 GBP, SA) 0.115*** dlog(@movav(fcpificeboiu.us(-2),4)) Brent crude oil futures price ($ per barrel, NSA) -0.006 dlog(fwhplq.igbr) Average nominal house prices (GBP, SA) 0.137*** dlog(fwstockpq.igbr) FTSE-100 Index 0.028** Real fixed investment (dlog(fwifl$q_igbr)); R2=0.36, 1999Q2-2012Q2 d(@movav(fwrmpolq.igbr-@pcy(fwcpiq.igbr),1)) BoE discount rate (NSA), real 0.008 dlog(fwgdpl$q.igbr(-1)) Real GDP (Bil. 2009 GBP, SAAR) 1.155*** dlog(fwstockpq.igbr(-2)) FTSE-100 Index 0.115*** 1 With“***” the variable is significant at 1%, with ”**” at 5% and with “*” at 10% 30
    31. 31. Consumption a Large Portion of the U.K. Output PRA U.K. GDP components, 2009£ bil, SAAR 1,700 1,600 C C+I C+I+G C+I+G+(X-M)=GDP 1,500 1,400 1,300 1,200 1,100 1,000 900 800 06Q1 08Q3 11Q1 13Q3 16Q1F 18Q3F 21Q1F 23Q3F Sources: ONS, Moody’s Analytics 31
    32. 32. Anchor Scenario Across Countries and Regions PRA GDP, % change yr ago 5 4 3 2 1 0 -1 -2 -3 -4 -5 -6 -7 08Q1 U.K. U.S. Euro zone Germany Spain 10Q3 13Q1 15Q3F 18Q1F 20Q3F 23Q1F Source: Moody’s Analytics 32
    33. 33. Fed U.S. Output Targets for CCAR Scenarios CCAR U.S. GDP, % change yr ago 4 3 2 1 0 -1 Baseline -2 Adverse -3 Severely Adverse -4 -5 08Q1 10Q3 13Q1 15Q3F Source: Moody’s Analytics 33
    34. 34. Severe Adverse Caused by a Euro Zone Crisis CCAR Severely Adverse GDP, % change yr ago 6 5 4 3 2 1 0 -1 -2 -3 -4 -5 -6 -7 U.K. U.S. 08Q1 10Q3 Euro zone 13Q1 Germany Spain 15Q3F Source: Moody’s Analytics 34
    35. 35. 7 Extension to Other Variables 35
    36. 36. House Prices Crush in the Anchor Scenario… PRA house prices, % change yr ago 12 10 8 6 4 2 0 -2 -4 -6 -8 -10 -12 -14 -16 -18 08Q1 U.K. U.S. Germany Spain 10Q3 13Q1 15Q3F 18Q1F 20Q3F 23Q1F Source: Moody’s Analytics 36
    37. 37. … Retail Sales Decline Initially… PRA retail sales, % change yr ago 10 8 6 4 2 0 -2 -4 -6 -8 -10 -12 08Q1 U.K. U.S. Germany Spain 10Q3 13Q1 15Q3F 18Q1F 20Q3F 23Q1F Source: Moody’s Analytics 37
    38. 38. … Unemployment Rises Rise PRA unemployment rate, % 35 Euro zone Germany Spain 30 25 20 15 10 5 08Q1 10Q3 13Q1 15Q3F 18Q1F 20Q3F 23Q1F Source: Moody’s Analytics 38
    39. 39. CCAR Unemployment CCAR unemployment rate, % 18 16 14 Europe Euro zone Latin America Developing Asia North America World Developed Asia 12 10 8 6 4 2 08Q1 10Q3 13Q1 15Q3F Source: Moody’s Analytics 39
    40. 40. 8 Financial Markets and Credit Risk 40
    41. 41. Market Variables and Credit Risk » Modelling of the term structure of Government yields. » Modelling of the term structure of swap rates. » Modelling of the term structure of corporate yields (or spreads to government yields) by ratings. » Modelling of 5-year sovereign CDS indices. » Modelling of rating migration matrices of global issuers of bonds rated by Moody’s Investors Service. » Return and volatility modelling of stock indices traded on the major global exchanges. » Return and volatility modelling of major bilateral spot foreign exchange rates. Decomposition of GDP into components. » Moody’s CreditCycle™ for econometric models 41
    42. 42. 42 Financial Models: PRA U.K. Swap Rate Curves Time-series of specific maturities for GBP swap rates History and forecasts, baseline and anchor scenarios 42
    43. 43. 43 Financial Models: CCAR U.K. Swap Rate Curves Time-series of specific maturities for GBP swap rates History and forecasts, CCAR Baseline, Severe, and Severely Adverse scenarios 43
    44. 44. 9 Concluding Remarks 44
    45. 45. Summary » U.K. Stress Testing Framework evolving to a more granular, frequent and rigorous approach (FDSF) » M.A. Scenario development: “map” the scenario assumptions to a large number of global macro, market, and credit factors (inputs into the ST framework). » PRA 2014: Delivery in 5 business days. Q&A Session Please send your questions to help@economy.com 45
    46. 46. 46 For more analysis and research on Europe and the global economy please visit www.economy.com 46
    47. 47. www.economy.com United States 121 North Walnut Street Suite 500 West Chester PA 19380 +1.610.235.5299 Australia Level 10 1 O'Connell Street Sydney, NSW, 2000 Australia +61.2.9270.8111 United Kingdom One Canada Square Canary Wharf London E14 5FA +44.20.7772.5454 Prague Washingtonova 17 110 00 Prague 1 Czech Republic +420.22.422.2929 47
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