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WHY ONE DIMENSIONAL STRESS TESTING NEEDS TO BE REINVIGORATED: TAKING A DUAL-TIME DYNAMICS APPROACH

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Hugh Morris, VP for Banking and Financial Services, Genpact

Banks are required to perform stress testing to ensure they are holding adequate quantities of capital to offset the effects of downturn events and potentially catastrophic losses that may arise from global crises.

British banks, including Barclays, Royal Bank of Scotland, and Lloyds will be subjected to stress tests this year, making up the 124 banks across the European Union. The aim is to reinstall consumer and business faith in the financial system following the global financial crisis of 2008 at both a system-wide and individual-institutional level.  The objective of the stress test results, presented in October of this year, will be to bolster public confidence in the stability of the system and demonstrate that bank can withstand a range of severe traumas devised by the banking authorities.

Hugh Morris

Hugh Morris

Previously, stress tests have been criticised for not being comprehensive enough, with most contemporary practices limited to one dimensional calculations. Scenarios under this system are based on values of exogenous macroeconomic variables, which fail to consider the impact of other endogenous risk factors.

A new method of stress testing optimises the process, combining the impacts of natural portfolio dynamics and macroeconomic performances to model and subsequently predict the portfolio performance. ‘Dual-time dynamics’ assess risk on both independent and dependent variables for example, a global economic downturn vs. a seasonal, yearly event such as Diwali.

A superior level of modelling is introduced as part of this approach, where customer time and age in the portfolio are considered to be additional endogenous characteristics contributing to portfolio performance.

Let’s now focus on some markets that will involve stress testing. As part of a European Union-wide test this year, The Bank of England will test whether lenders can adequately withstand a shock to the property market. It has emerged that buyers are spending a higher proportion of their incomes on mortgages than at any time since 2005.  We are seeing a tougher home loan underwriting process and UK lenders being required to adopt more rigid practices when assessing prospective borrowers’ mortgage applications, which can involve dissecting income and bank statements.

It’s not only the West that requires stress tests. It has been reported that the China Banking Regulatory Commission (CBRC) has announced that it will conduct regional and national stress tests after banks saw a spike in bad loans last year. Chinese banks are reeling from the aftermath of a huge lending binge that policymakers unleashed to soften the impact of the global financial crisis in 2008. The CBRC guidelines have stated that it’s important that banks do not hide from the true scale of their exposure to bad loans by offering new ones. Banks should instead analyse the risk within each key region, focusing on certain industries and clients.

That being said, a discrepancy in stress testing has been identified by some analysts in the US who believe that even with the new measures being put in place across Europe, the European banks would still not be comprehensive enough to withstand US tests. The difference in approach to stress testing has been viewed as the result of a key difference in the make-up of the Euro Zone and US economies. U.S. banks make up a greater percentage of the U.S. economy whereas this is smaller in Europe.  However, it will be difficult to measure how tough the stress tests are until they are completed and US stress tests provide valuable information for European market participants identifying where any lessons can be learnt.

It’s therefore essential that banks from both the West and the East use the right strategies to stress testing. If they are to engage in supporting World economic growth, a holistic and comprehensive ‘Dual-Time Dynamics’ approach must be deployed.

Banking

European shares end higher on strong earnings, positive data

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By Sagarika Jaisinghani and Ambar Warrick

(Reuters) – Euro zone shares rose on Friday, marking a third week of gains, as data showed factory activity in February jumped to a three-year high, while upbeat quarterly earnings boosted confidence in a broader economic recovery.

The euro zone index was up 0.9%, with strong earnings from companies such as Acciona and Hermes brewing some optimism over an eventual economic recovery.

The pan-European STOXX 600 index rose 0.5%, as regional factory activity was seen reaching a three-year high on strong demand for manufactured goods at home and overseas.

Another reading showed the euro zone’s current account surplus widened in December on a rise in trade surplus and a narrower deficit in secondary income.

Still, the STOXX 600 marked small gains for the week, having dropped for the past three sessions as investor concern grew over rising inflation and a rocky COVID-19 vaccine rollout.

But basic resources stocks outpaced their peers this week with a 7% jump, as improving industrial activity across the globe drove up commodity prices.

“This week’s slightly adverse price action has all the hallmarks of a loss of momentum temporarily and not a structural turn,” said Jeffrey Halley, senior market analyst at OANDA.

“There is not a major central bank in the world thinking about taking their foot off the monetary spigot, except perhaps China. (Markets) will remain awash in zero percent central bank money through all of 2021 (and) a lot of that will head to the equity market.”

Minutes of the European Central Bank’s January meeting, released on Thursday, showed policymakers expressed fresh concerns over the euro’s strength but appeared relaxed over the recent rise in government bond yields.

The bank’s relaxed stance was justified by the euro zone economy requiring continued monetary and fiscal support, as evidenced by a contraction in the bloc’s dominant services industry in February.

The STOXX 600 has rebounded more than 50% since crashing to multi-year lows in March 2020, with hopes of a global economic rebound this year sparking demand for sectors such as energy, mining, banks and industrial goods.

London’s FTSE 100 lagged regional bourses on Friday due to a slump in January retail sales and as the pound jumped to its highest against the dollar in nearly three years. [.L] [GBP/]

French carmaker Renault tumbled more than 4% after posting a record annual loss of 8 billion euros ($9.68 billion), while food group Danone and German insurer Allianz rose following upbeat trading forecasts.

(Reporting by Sagarika Jaisinghani in Bengaluru; Editing by Sriraj Kalluvila and Shailesh Kuber)

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Banking

ECB plans closer scrutiny of bank boards

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ECB plans closer scrutiny of bank boards 2

FRANKFURT (Reuters) – The European Central Bank plans to increase scrutiny of bank board directors and will take look more closely at diversity within management bodies, ECB supervisor Edouard Fernandez-Bollo said on Friday.

The ECB already examines the suitability of board candidates in a so-called fit and proper assessment, but rules across the 19 euro zone members vary, so the quality of these checks can be inconsistent.

The ECB plans to ask banks to undertake a suitability assessment before making appointments, and they will put greater emphasis on the candidates’ previous positions and the bank’s specific needs, Fernandez-Bollo said in a speech.

The supervisor also plans more detailed rules on how it will reassess board members once new information emerges, particularly in case of breaches related to anti-money laundering and financing of terrorism, Fernandez-Bollo added.

Fernandez-Bollo did not talk about enforcing diversity quotas, but he argued that diversity, including diversity in gender, backgrounds and experiences, improves efficiency and was thus crucial.

“Supervisors will consider furthermore all of the diversity-related aspects that are most relevant to enhancing the individual and collective leadership of boards,” he said.

“Diversity within a management body is therefore crucial … there is a lot of room for improvement in this area in European banks,” he said.

(Reporting by Balazs Koranyi, editing by Larry King)

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Banking

Where are we with Open Banking, and should we be going further?

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Where are we with Open Banking, and should we be going further? 3

By Mitchel Lenson, Non-Executive Chairman, Exizent

Open Banking has the power to revolutionise the way we manage our money, but most (65%) consumers are still not aware of it, while many financial institutions continue to treat it as an obligation rather than an opportunity.

For Open Banking to truly reach its potential, consumers need to have more trust in its benefits. However, this will only happen if banks and other financial institutions start to embrace it, rather than simply accept it.

Covid-19 has proven to banks that digital banking and open finance innovation is not simply a ‘nice to have’. It is vital for their own survival. With so many challenger banks now coming into the market, many of whom have entirely digital models and therefore invest heavily in technology, banks are starting to become aware that if they don’t embrace it, they’ll get left behind.

So, fuelled by a mixture of competition and Covid-19, banks are starting to realise that Open Banking is not about giving away valuable data, but it is about collaborating with third party fintechs to explore the endless opportunities data sharing can bring – to all sides.

By making open finance easier for developers, banks can not only save time and money by improving their own services but help create useful solutions that add real value for their customers.

Open Banking for all?

There is one, yet untapped area of consumer finance that could be immeasurably improved by Open Banking, and that is estate administration.

Mitchel Lenson

Mitchel Lenson

Recent research from Which? found that many executors contend with delays, errors and poor knowledge from their banks during the probate process. Our own research shows that most legal professionals admit the process does not work as it should, and the time it takes to complete probate is unacceptable.

Like the Which? survey, we found that the main issue is the administration involved, with most legal professionals saying that the time it takes for financial institutions to get back to them with the information they need is the main cause of delays.

Given that the system is not working for consumers, something clearly needs to be done. The good news is that the technology and data is already available – we just need to harness it to create a better system.

That is why we are developing the first ever platform to connect executors, legal professionals, and financial institutions to create a better, quicker, and more secure probate experience for everyone.

Our first release of the platform – a bespoke cloud-based solution to enable legal services firms to integrate directly with financial institutions making information gathering and processing more straightforward – was released in 2020. We are now building on that foundation to accelerate our development work with financial institutions to deliver additional value for all sides.

We also see huge potential in working with banks to utilise the digital financial infrastructure, powered by Open Banking, to improve things even further. But there is one, fairly sizeable issue – currently, Open Banking consent ceases at the point of death.

Is it time for legislative change?

Open Banking is not as open as is should be for those who can give consent, so we are certainly some way off from Open Banking for the deceased.  However, the more that banks acknowledge Open Banking and its potential and are prepared to collaborate with third party fintechs to develop better experiences for consumers, the more likely we are to get to a point where we can tap into that potential to improve things for the bereaved.

Many of the problems – highlighted by Which? – that consumers face when managing someone’s estate could be reduced significantly if open finance continued to apply to the deceased.

Open Banking provides a huge opportunity to speed-up and reduce friction for loved ones faced at some of the hardest moments of their lives, and there is a strong argument here for the current position to be reviewed to enable better access to a deceased person’s assets.

With our current platform, we are showing how technology is playing an incredibly significant role in dealing with the complex, tangled process that is probate and the potential of open finance in radically enhancing what we are already doing cannot be understated.

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