Macro Stress-Testing Credit Risk in Romanian Banking System

This report presents an application of a macro stress testing procedure on credit risk in the Romanian banking system. Macro stress testing, i.e. assessing the vulnerability of financial systems to exceptional but plausible macroeconomic scenarios, maintains a central role in macro-prudential and crisis management frameworks of central banks and international institutions around the globe. Credit risk remains the dominant risk challenging financial stability in the Romanian financial system, and thus this report analyses the potential impact of macroeconomic shocks scenarios on default rates in the corporate and household loan portfolios in the domestic banking system. A well-established reduced form model is proposed and tested as the core component of the modelling approach. The resulting models generally confirm the influence of macroeconomic factors on credit risk as documented in previous research including applications for Romania, but convey also specific and novel findings, such as inclusion of leading variables and construction activity level for corporate credit risk. Using the estimated model, a stress testing simulation procedure is undertaken. The simulation shows that under adverse shock scenarios, corporate default rates can increase substantially more than the expected evolution under the baseline scenario, especially in case of GDP shock, construction activity shock or interest rate shocks. Under the assumptions of these adverse scenarios, given also the large share of corporate loans in the banks’ balance sheet, the default rates evolution could have a substantial impact on banks’ loan losses. The households sector stress testing simulation show that this sector is more resilient to macroeconomic adverse evolutions, with stressed default rates higher than expected values under baseline scenario, but with substantially lower deviations. The proposed macro-perspective model and its findings can be incorporated by private banks in their micro-level portfolio risk management tools. Additionally, supplementing the authorities’ stress tests with independent approaches can enhance credibility of such financial stability assessment.