EBA stress test meets IFRS 9

1. Setting the scene

On 17th November 2017 the EBA published the final methodology for the 2018 EU wide stress test.[1] The stress test exercise was launched in January 2018 with the publications of the macroeconomic scenarios. The first submission of results to the EBA is planned for early June of the same year. The final submission to the EBA is expected by late October. The final results will be published by the 2nd November 2018. The stress test will cover 48 selected large EU banks. Similar to previous exercises the current stress test focuses on the assessment of the impact of risk drivers on the solvency of banks. The risk drivers are categorised into credit risk, market risk, counterparty credit risk and operational risks. However, this time, the credit risk section is updated to incorporate the new requirements from IFRS 9 - Financial Instruments. Participating banks are required to project the effects of a baseline and adverse macroeconomic scenario on P&L and capital positions while strictly complying with EBA methodology. At the same time, they have to take into account the effect of IFRS 9 for the starting point (1st January 2018) and projections (2018-2020) during the stress test horizon. That means that banks have to manage the balancing act of applying their implement accounting approach for IFRS 9 and fulfil the EBA methodology for credit risks at the same time.

2. Intense first quarter 2018

By end of March 2018 banks are required to have finally implemented the IFRS 9 requirements in order to set up an IFRS 9 opening balance, conduct three month-end closings and prepare the first quarterly financial statement. Besides the EBA stress test also other regulatory initiatives require the IFRS 9 starting balance in the first quarter 2018. FINREP / COREP reports for 31st March 2018 have to be submitted by 12th May 2018 and also include quarterly opening and ending balances for credit loss allowance.[2] The agglomeration of regulatory exercises that require IFRS 9 figures in the first quarter of 2018 and the fact that many banks report delay in their IFRS 9 implementation projects has provoked harsh criticism from the banking industry with regards to EBA timelines.

3. EBA vs. IFRS 9: Diverging requirements for credit risk

The EBA has defined general assumptions for the stress tests. Some of the assumptions for credit risk are in conflict with the general IFRS 9 Impairment requirements.


  • Single scenario assumption and perfect foresight: Banks are requested to forecast the development of their credit loss allowance (impairment) based on a single scenario, i.e. for both the baseline and the adverse scenario. On the contrary, IFRS 9 defines the expected credit loss as probability-weighted estimate of credit losses over the expected life of the financial instruments (IFRS Thus probability-weighted approach of IFRS 9 is replaced by the EBA`s perfect foresight assumption.

  • Stage definition and transfers: Although banks are required to use their implemented IFRS 9 stage model to simulate stage transfers, EBA has introduced several extensions and restrictions to the definition of and movement between impairment stages. The EBA Stage 3 definition includes non-performing and defaulted exposure (EBA ITS) irrespective of the implemented IFRS 9 Stage 3 criteria. As a mandatory stage 3 criteria the relative increase criterion of 200% is introduced. Transfers from Stage 3 to Stage 1 or 2 are prohibited. The additional requirements force banks to develop a transformed stage transfer methodology which for many banks depicts a methodological denature away instead of a representation of their implemented IFRS 9 models.

  • Risk parameters: According to the EBA methodology, the lifetime expected credit loss is calculated by multiplying the lifetime probability of default (PD) with the lifetime loss given default (LGD). This simplified approach is not consistent to the expected credit loss calculation methodology implemented in most banks for IFRS 9. Instead, the lifetime expected credit loss is computed as the total of the discounted marginal factors in various time slices over 1-year or lifetime of a financial instrument. For the EBA stress test the terminology of PD is “extended” as a convention to denote the probability of stage transfer and not merely transfer to default (e.g. LT PD12 denotes the lifetime transfer probability between S1 and S2). The notion of LGD refers to expected credit loss of possible default events associated with assets that transfer across stages (e.g. LT LGD12 denotes the lifetime losses associated with assets transferring from S1 to S2). Therefore, the EBA methodology requires to compute new risk parameters which can be used for stress testing only.


Figure 1: Detailed analysis of the stress test methods shows that the EBA understands key terms of the new IFRS 9 impairment model differently.

4. Project set-up and issues

In terms of organisational delivery, the stress test can be organised and performed in a central or decentral setting:


  • Central: Local delivery of “un-stressed” counterparty, accounting and risk data and central calculation of “stressed” risk parameters, simulation of stage transfers, projection of impairments and filling of reporting templates

  • Decentral: Local calculation of required “stressed” risk parameters, simulation of stage transfers, projection of impairments and central filling of reporting templates

  • Different hybrid settings are possible as well  


The organisational setting of the stress test often depends on the implemented IFRS 9 infrastructure. In our experience banking groups opt for central solutions with dedicated (and often self-developed) stress test tools which have been upgraded to meet the new EBA requirements for credit risk. Alternatively, banks leverage their implemented IFRS 9 expected credit loss engines for stress test purposes.


Figure 2: The new IFRS 9 architecture is used as a foundation for the targeted determina-tion of impairment figures for the 2018 EBA stress test in the banking group

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[1] On 31st January, the EBA has published an amendment to the final version that includes minor corrections.

[2] At the beginning of December 2016, the European Banking Authority (EBA) published the final Implementing Technical Standard (ITS) on amendments to reporting of financial information (FINREP) due to IFRS 9.