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Stress testing household balance sheets in Luxembourg

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  • Gaston Giordana

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  • Michael Ziegelmeyer

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Abstract

This paper uses individual household data from Luxembourg to evaluate how severe economic conditions could affect bank exposure to the household sector. Using data from a representative survey, information on household income, expenses and liquid assets are used to calculate a household-specific probability of default (PD). Aggregate bank exposure at default (EAD) is obtained by multiplying these household-level PDs by their corresponding volume of outstanding loans and summing across the population of households. Aggregate bank loss given default (LGD) is calculated by assuming that banks recover real estate assets from defaulting households and liquidate them with a haircut. To simulate adverse economic conditions, the exercise is repeated with scenarios combining severe but plausible shocks (i.e. tail risk) to real estate prices, bonds and stocks, household income and interest rates. Compared to the no-shock baseline, the LGD rises by a multiple of eight, reaching 4.2% of total bank exposure to the household sector. Thus, bank losses appear to be quite sensitive to severe stress. The high-stress scenario also generates a relatively high percentage of defaults among socioeconomically disadvantaged households (i.e. low net wealth, low income, low education, three or more dependent children). For instance, households in the lowest income quintile see their PD rise from 9.3% in the no-shock baseline to 14.8% in the most severe scenario. Our main conclusion is that bank losses appear to be quite sensitive to financial stress, despite three mitigating factors in Luxembourg: indebted households tend to hold liquid assets that can help smooth shocks, household leverage tends to decline rapidly once mortgages have been serviced several years, and loan-to-value ratios at origination appear not to be excessive. Classification-JEL D10, D14, E44, G01, G21

Suggested Citation

  • Gaston Giordana & Michael Ziegelmeyer, 2018. "Stress testing household balance sheets in Luxembourg," BCL working papers 121, Central Bank of Luxembourg.
  • Handle: RePEc:bcl:bclwop:bclwp121
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    References listed on IDEAS

    as
    1. Gaston Giordana & Michael Ziegelmeyer, 2017. "Household debt burden and financial vulnerability in Luxembourg," IFC Bulletins chapters, in: Bank for International Settlements (ed.), Data needs and Statistics compilation for macroprudential analysis, volume 46, Bank for International Settlements.
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    More about this item

    Keywords

    Stress testing; Financial stability; HFCS; Household finance;

    JEL classification:

    • D10 - Microeconomics - - Household Behavior - - - General
    • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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