Wednesday, January 22, 2025

THE SCENARIOS OF BANKS' STRESS TESTS

 Filenews 22 January 2025



The stress tests for systemic banks in the Eurozone officially begin and the difference compared to previous stress tests is that the parameter of geopolitical risks will have a greater impact on the results.

The sampled banks will be tested under two scenarios, basic and adverse, which is clearly more extreme than in the past. This year's exercise is designed to provide valuable input to assess the resilience of the European banking sector in the current uncertain and changing macroeconomic environment. The severe scenario (a cumulative fall in EU GDP of 6.3%) is based on a narrative of a hypothetical worsening of geopolitical tensions, with large, negative and persistent trade and confidence shocks having strong negative effects on private consumption and investment, both domestically and globally.

At the same time, the ECB will conduct its own stress test on 45 medium-sized banks (Bank of Cyprus participates but the name of the Greek Bank does not appear on the list). Eurobank is also excluded from the stress test in Greece due to the consolidation with Hellenic Bank and the upcoming merger with Eurobank Cyprus in 2025. The ECB plans to publish the results of both stress tests in early August 2025. The results will shed light on how hypothetical adverse shocks affect banks' resilience under challenging macroeconomic conditions.

The assumptions for the evolution of key macroeconomic data in Cyprus are as follows:

The baseline scenario for Cyprus based on the extreme (adverse) scenario has two negative signs and one positive in terms of growth in the 3-year period 2025-2027 (-2.4%, -4.7% and positive 0.7% for 2027). The baseline for 2025 envisages a growth rate of 3%, for 2026 at 3.1% and for 2027 at 3%. In the euro area under the extreme scenario, it forecasts negative growth of -2.3% in 2025, -4.2% in 2026 and 0% in 2027.

Unemployment in the extreme, adverse scenario for Cyprus would be 8.3% in 2025, 11.6% in 2026 and 11.8% in 2027. In the baseline scenario it is 4.9% in 2025, 4.7% in 2026 and 4.6% in 2027. In the euro area, under the extreme scenario, unemployment is 8.1% in 2025, 10.6% in 2026 and 11.9% in 2027.

Inflation will reach 2.7% in 2025 before declining 2.1% in 2026 and reaching 2.7% in 2027 under the severe scenario, while in the baseline scenario it runs at 1.9% in 2025, rises to 2.1% in 2026 and falls to 2% in 2027. In the euro area, under the severe scenario, inflation is 4.5% in 2025, 3.3% in 2026 and 2% in 2027.

Real estate prices, which are a critical parameter of the stress test, in the extreme scenario predict a decline in both residential and commercial real estate. For residential real estate in particular, prices in the extreme scenario fall 3.4% this year, 9.5% in 2026 and 6.1% in 2027. The baseline projects growth of 4.7% in 2025, 3% in 2026 and 2.5% in 2027.

In the euro area, in the extreme scenario, residential real estate prices fall 3.1% in 2025, to 7.9% in 2026 and 4.5% in 2027. For commercial real estate, the severe scenario projects a decrease of 8.6% in 2025, 14.7% in 2026 and 11.6% in 2027. In the baseline scenario, growth of 2.3% in 2025, 1.1% in 2026 and 0.7% in 2027. In the euro area in the severe scenario, the decline is projected at 9.1% in 2025, to 13.6% in 2026 and 9.1% in 2027.