Spotting problems and keeping them from mounting up Given the limited time we have, I have given you a very brief overview of what resolving a bank entails. It is a gruesome and complex event, and one which is best avoided, but not at all costs. To avoid failure, banks and supervisors must spot problems early on and address them quickly. Since the crisis, stress tests have become an important tool for helping us to do this. Stress tests basically assess how banks would fare in various hypothetical scenarios involving different future paths for the economy and the financial markets. Usually, there is a baseline scenario, where things develop as expected. And then there is an adverse scenario, where they don’t: inter alia, GDP, unemployment and property prices are stressed two years ahead in this scenario. So you can see that the key idea of a stress test is to assess how banks would cope if the going gets tough; it’s all purely hypothetical, of course. Stress tests allow us to make a consistent assessment. Each bank has to apply the same scenarios and calculate their impact in the same way. This means that the results can be compared across banks. And stress tests provide a glimpse of the bank’s risk management in action. How quickly can it process the scenarios and assess their impact on [the state of] the bank? This is important information about the quality of governance. But the main focus of stress tests is on capital.
Sabine Lautenschläger: The banks and the market Speech by Ms Sabine Lautenschläger, Member of the Executive Board of the European Central Bank and Vice-Chair of the Supervisory Board of the European Central Bank, at a Lecture at the Florence School of Banking and Finance, Florence, 15 March 2018. * * * Almost ten years ago to the day, the world of finance was shaken by a strong tremor. On 16 March 2008, JP Morgan offered to buy the investment bank Bear Stearns. And it was time. Bear Stearns was in deep trouble: its share price had fallen by two-thirds since the beginning of that year; it was bleeding money; and it was basically shut out of the funding market. At the time, the failure of Bear Sterns was considered a major event. No one knew that the big quake was still to come. It happened half a year later, on 15 September 2008, when another investment bank failed: Lehman Brothers. It pushed the financial system close to the abyss. Trust evaporated, markets dried up, and around the globe, banks were sent reeling. All in all, it was the biggest financial crisis in decades. It dragged down the real economy, which fell into what we now call the Great Recession. In the euro area, economic output went down by almost 4.5% in 2009, while unemployment jumped by more than a quarter to 9.6%. Three years later, it reached 12%.