Briefing on the Bank of England Stress Test

Briefing on the Bank of England Stress Test:Common & Bespoke Scenarios

Dr. PETR ZEMCIK, DIRECTOR

2

Introduction1

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3

About Moody’s Analytics

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Forecasts with Alternative Scenarios

Risk Management, Strategic Planning, Business and Investment Decisions

Macro, Financial Data and Economic Research

Regulatory Stress Test Advisory Services

Consumer Credit Analytics

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Today’s Speaker

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Dr. Petr Zemcik, Director Chief European EconomistDr. Zemcik supervises a group of economists responsible for analysis, modeling,

and forecasting for Europe. He holds a PhD and MA in Economics from the University of Pittsburgh and MSc in Econometrics and Operations Research from the University of Economics in Prague.

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» Introduction» Regulatory Scenarios Framework» Interest Rates Paths» Foreign Exchange Rates: Fundamentals & No Arbitrage» Fed Taper 2014: FX & Yield Shock» Output Projections: U.K. and Other Countries and Regions» Extension to Other Variables» Financial Models And Credit Risk» Concluding Remarks

Agenda

77

Please send your questions to

help@economy.com

7

8

Regulatory Scenario Framework2

99

» January 10 – Firms submit high-level risks to PRA*» January 31 – PRA provides comments on risks explored by firms*» February 24 – Firms submit worked-up scenario.*» March 12 – banks submit detailed portfolio data up to yr-end 2013.» March 31 – PRA baseline and stress scenarios published.» April 4 – official submission of bespoke scenarios.*» April 4 – MA completes forecasts for PRA baseline and stress Scenarios.» April 9 – MA completes narratives for PRA baseline and stress Scenarios.» April 30 – PRA board approves risks.*» Q2 – banks analyse impact of scenarios.» June 30 – results approved by each bank’s Board submitted to the PRA.» Q2/Q3 – The BoE runs regulatory models and compares results with

banks’ analysis. The BoE also conducts system-wide & feedback analysis.» Q4 – FPC/PRA Board decisions and disclosure.

* Dates related to bespoke scenario development.

Expected PRA 2014 Stress Test Timeline

1010

Regulatory and MA Stress ScenariosPRA Anchor Scenario 2013H2- Dual banking and sovereign debt crisis. - High/low interest path

FED CCAR 2013 ScenariosAdverse Scenario- High interest rates, low inflation- Motivated by the Great Recession, FED TaperSeverely Adverse Scenario- Euro zone crisis, global recession

MA Stress ScenariosEuro Zone Crisis (“S4”)- Dual banking and sovereign debt crisis, Grexit. Oil Price Shock (“S6”)- Stagflation, high interest rates

1111

» PRA 2013H2– Provided series: 14 U.K., 14 U.S., 2 Euro Zone– MA: 19 countries, 2 regional aggregates – Euro Zone and Asian-Pacific

» CCAR 2013– Provided series: 16 U.S., 3 EUZN, 3 DA, 3 U.K.– MA: 36 countries, 9 regional aggregates– Delivery in business days: U.S. 3 days, countries 4 days, regional aggregates 5 days –

World, North America, South America, Developed Asia, Developing Asia, Europe, Euro Zone, Middle East and Africa, Oceania

– 30 US CCAR banks.

» MA Models/Capacity– U.S. model 1600+ variables– 55 country models, 60+ variables each– Financial market and credit risk models– Numerous satellite support models

PRA/BoE & CCAR/Fed Scenarios in Numbers

1212

Moody’s Analytics Country Model Design

Exchange rates

Investment

Wages and salaries

Population

Prices

GDP

Monetary policy rate

Imports

Government

Exports

Global GDP

Unemployment rate

Consumption

Labor force

Employment

Potential GDP

Other deflators

Import prices

10-yr yield

Global prices

13

Interest Rates Paths3

1414

Variable Description Coef.1

Real 10-yr yields(fwrgt10yq.igbr-@pcy(fwcpiq.igbr)); R2=0.63, 1995Q4-2013q3

C constant 0.72*

@movav(@pcy(fwgdplq_igbr(-1)),3)Nominal GDP (Bill. GBP, SAAR) - 0.09

fwrmpolq.igbr-@pcy(fwcpiq.igbr) BoE discount rate (NSA), real 0.84***

@movav((fwggbblq_igbr/fwgdplq_igbr),4)Budget balance ratio to nominal GDP(SA)

- 81.37***

Monetary policy rate (dlog(fwrmpolq.igbr)); R2=0.54, 1998Q2-2013q3

C constant - 0.09***

d(fwlbrq.igbr-fnairu.igbr) Unemployment gap (SA) - 0.39***

dlog(@movav(fwcpiq_igbr(),1))Consumer price index(2005=100, SA) 9.42***

Fundamentals Drive Interest Rates in Long-Run

1 With“***” the variable is significant at 1%, with ”**” at 5% and with “*” at 10%

1515

0

1

2

3

4

5

6

7

8

9

Actual 10-yr bond yieldFitted 10-yr bond yieldActual policy rateFitted policy rate

Policy Rates and Yields Fitted vs. ActualU.K. rates, %

Source: Moody’s Analytics

1616

0

1

2

3

4

5

6U.K. U.S. Euro zone

Assumptions for the PRA Policy RatesPRA policy rates, %

Sources: ECB, BoE, Fed, Moody’s Analytics

1717

1

2

3

4

5

6

7U.K. U.S. Euro zone Germany Italy

Yields in the Low Path Anchor ScenarioPRA 10-yr government bond yields, %

Sources: ECB, BoE, Fed, IMF, Bank of Italy, Moody’s Analytics

1818

0

1

2

3

4

5

6

7

810-yr govt. bond yield 3-mo libor

NFC loan rate BoE policy rate

NFC Loan Rate DeterminationPRA, U.K. rates, %

Sources: BoE, BBA, ONS, Moody’s Analytics

19

Exchange Rates:Fundamentals & No Arbitrage4

2020

1.4

1.6

1.8

2.0

Good Fit for GBP/USD Exchange Rate$ per £, log(fwtfxiusaq.igbr); R2=0.42, 1998Q1-2012Q3

Source: Moody’s Analytics

Variable Description Coef.1

C constant - 0.74***

log(fwcpiq.iusa/fwcpiq.igbr) U.S.- U.K. inflation gap 1.99***

log(fwrmpolq.igbr/fwrmpolq.iusa)U.K.- U.S. policy rate gap

- 0.05***

1 With“***” the variable is significant at 1%, with ”**” at 5% and with “*” at 10%

2121

80

90

100

110

120

130

140Pound per $ Euro per $ Yen per $

Dollar Depreciates in the Anchor ScenarioPRA exchange rates, 2013Q4=100

Source: Moody’s Analytics

2222

70

80

90

100

110

120

130Pound per $ Euro per $ Yen per $

The Fed Sets Main Exchange RatesCCAR exchange rates, Severely Adverse Scenario, 2013Q3=100

Source: Moody’s Analytics

23

Fed Taper 2014:FX and Yield Shock5

2424

Jan-08Jan-08Jan-08Jan-08Feb-08Feb-08Feb-08Feb-08Feb-08Mar-08Mar-08Mar-08Mar-08Apr-08Apr-08Apr-08Apr-08May-08May-08May-08May-08May-08Jun-08Jun-08Jun-08Jun-08Jul-08Jul-08Jul-08Jul-08Aug-08Aug-08Aug-08Aug-08Aug-08Sep-08Sep-08Sep-08Sep-08Oct-08Oct-08Oct-08Oct-08Oct-08Nov-08Nov-08Jan-09Jan-09Jan-09Jan-09Jan-09Feb-09Feb-09Feb-09Feb-09Mar-09Mar-09Mar-09Mar-09Apr-09Apr-09Apr-09Apr-09May-09May-09May-09May-09May-09Jun-09Jun-09Jun-09Jun-09Jul-09Jul-09Jul-09Jul-09Jul-09Aug-09Aug-09Aug-09Aug-09Sep-09Sep-09Sep-09Sep-09Oct-09Oct-09Oct-09Oct-09Oct-09Nov-09Nov-09Nov-09Nov-09Dec-09Dec-09Dec-09Dec-09Jan-10Jan-10Jan-10Jan-10Jan-10Feb-10Feb-10Feb-10Feb-10Mar-10Mar-10Mar-10Mar-10Apr-10Apr-10Apr-10Apr-10Apr-10May-10May-10May-10May-10Jun-10Jun-10Jun-10Jun-10Jul-10Jul-10Jul-10Jul-10Jul-10Aug-10Aug-10Aug-10Aug-10Sep-10Sep-10Sep-10Sep-10Oct-10Oct-10Oct-10Oct-10Oct-10Nov-10Nov-10Nov-10Nov-10Dec-10Dec-10Dec-10Dec-10Dec-10Jan-11Jan-11Jan-11Jan-11Feb-11Feb-11Feb-11Feb-11Mar-11Mar-11Mar-11Mar-11Apr-11Apr-11Apr-11Apr-11Apr-11May-11May-11May-11May-11Jun-11Jun-11Jun-11Jun-11Jul-11Jul-11Jul-11Jul-11Jul-11Aug-11Aug-11Aug-11Aug-11Sep-11Sep-11Sep-11Sep-11Sep-11Oct-11Oct-11Oct-11Oct-11Nov-11Nov-11Nov-11Nov-11Dec-11Dec-11Dec-11Dec-11Dec-11Jan-12Jan-12Jan-12Jan-12Feb-12Feb-12Feb-12Feb-12Mar-12Mar-12Mar-12Mar-12Mar-12Apr-12Apr-12Apr-12Apr-12May-12May-12May-12May-12Jun-12Jun-12Jun-12Jun-12Jun-12Jul-12Jul-12Jul-12Jul-12Aug-12Aug-12Aug-12Aug-12Aug-12Sep-12Sep-12Sep-12Sep-12Oct-12Oct-12Oct-12Oct-12Nov-12Nov-12Nov-12Nov-12Nov-12Dec-12Dec-12Dec-12Dec-12Jan-13Jan-13Jan-13Jan-13Feb-13Feb-13Feb-13Feb-13Mar-13Mar-13Mar-13Mar-13Mar-13Apr-13Apr-13Apr-13Apr-13May-13May-13May-13May-13May-13Jun-13Jun-13Jun-13Jun-13Jul-13Jul-13Jul-13Jul-13Aug-13Aug-13Aug-13Aug-13Aug-13Sep-13Sep-13Sep-13Sep-13Oct-13Oct-13Oct-13Oct-13Nov-13Nov-13Nov-13Nov-13Nov-13Dec-13Dec-13Dec-13Dec-13Jan-141.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5U.S. Germany U.K. Fed tapering

first mooted in May 13

Tapering con-firmed to start Jan 14

German Yields Decouple From the U.S. and U.K.

Sources: Bloomberg, Moody’s Analytics

10-yr government bond yields, %

2525

Germany France Italy Spain0.0

0.5

1.0

1.5

2.0

2.5

3.0

BaselineBond yield spike 100 bpsEuro 10% depreciationCombined impact

Fed Tapering Could Affect European GrowthReal GDP growth in 2014 under alternative assumptions, %

Source: Moody’s Analytics

26

Output Projections: U.K. and Other Countries and Regions6

2727

» GDP targets across countries and scenarios

– Time series regressions – Severity

» Decomposition of GDP into components

» Aggregates (e.g. Euro zone)– Bottom-up approach– Targeting

Challenges

2828

Variable Description Coef.1

German GDP (dlog(fwgdpl$q_ideu)); R2=0.84, 2000Q2- 2013Q2

C constant -0.0003

dlog(fgdp$_fedb.us)U.S. real GDP under Fed CCAR baseline (Bil. 2009 USD, SAAR)

-0.013

dlog(fwgdpl$q_fedb.ieuzn) Euro zone real GDP under Fed CCAR baseline (Bil. 2005 EUR, SAAR)

1.312***

dlog(fwgdpl$q_fedb.igbr) U.K. real GDP under Fed CCAR baseline (Bil. 2009 GBP, SAAR) -0.249*

dlog(fwgdpl$q_fedb.ijpn)Japan real GDP under Fed CCAR baseline (Bil. 2005 JPY, SAAR)

0.130*

dlog(gdp_febd_asia)Developing Asia real GDP under Fed CCAR baseline ( Bil. 2009 USD, SAAR)

0.025

dlog(fwgdpl$q_ideu(-1))Germany real GDP (Bil. 2005 EUR, SAAR)

0.030

Germany CCAR Target Estimation

1 With“***” the variable is significant at 1%, with ”**” at 5% and with “*” at 10%

2929

U.S. U.K. Euro Zone

Start-to-trough, %

PRA -4.6 -4.8 -5.2

CCAR Adverse -0.4 -0.9 -1.6CCAR Severely Adverse -2.1 -3.7 -3.9

S4 -4.3 -4.4 -4.8

Probability of a worse start-to-trough, %

PRA 4.6 1.5 3.3

CCAR Adverse 34.5 16 23.3CCAR Severely Adverse 17 2.7 8.1

S4 5.5 1.6 4.4

Anchor Scenario Is the Most Severe

3030

Variable Description Coef.1

Real household consumption per capita (dlog((fwcl$q_igbr/fwpopq_igbr)); R2=0.56, 1995Q3-2012Q2

@movav(d(fwrgt10yq.igbr-@pcy(fwcpiq.igbr)),3)10-year discount bond yield (NSA), real

-0.003

pdl(dlog((fwypdlq.igbr()/(fwcpiq.igbr()*fwpopq.igbr()))),4,2,3)

Real disposable income per capita (Bil. 2005 GBP, SA)

0.115***

dlog(@movav(fcpificeboiu.us(-2),4)) Brent crude oil futures price ($ per barrel, NSA)

-0.006

dlog(fwhplq.igbr)Average nominal house prices (GBP, SA)

0.137***

dlog(fwstockpq.igbr) FTSE-100 Index 0.028**

Real fixed investment (dlog(fwifl$q_igbr)); R2=0.36, 1999Q2-2012Q2

d(@movav(fwrmpolq.igbr-@pcy(fwcpiq.igbr),1)) BoE discount rate (NSA), real 0.008

dlog(fwgdpl$q.igbr(-1)) Real GDP (Bil. 2009 GBP, SAAR) 1.155***

dlog(fwstockpq.igbr(-2)) FTSE-100 Index 0.115***

Investment And Consumption in the U.K.

1 With“***” the variable is significant at 1%, with ”**” at 5% and with “*” at 10%

3131

800

900

1,000

1,100

1,200

1,300

1,400

1,500

1,600

1,700C C+I C+I+G C+I+G+(X-M)=GDP

Consumption a Large Portion of the U.K. OutputPRA U.K. GDP components, 2009£ bil, SAAR

Sources: ONS, Moody’s Analytics

3232

-7-6-5-4-3-2-1012345

U.K.

U.S.

Euro zone

Germany

Spain

Anchor Scenario Across Countries and Regions

PRA GDP, % change yr ago

Source: Moody’s Analytics

3333

-5

-4

-3

-2

-1

0

1

2

3

4

Baseline

Adverse

Severely Adverse

Fed U.S. Output Targets for CCAR ScenariosCCAR U.S. GDP, % change yr ago

Source: Moody’s Analytics

3434

-7-6-5-4-3-2-10123456

U.K. U.S. Euro zone Germany Spain

Severe Adverse Caused by a Euro Zone CrisisCCAR Severely Adverse GDP, % change yr ago

Source: Moody’s Analytics

35

Extension to Other Variables7

3636

-18

-14

-10

-6

-2

2

6

10

U.K.

U.S.

Germany

Spain

House Prices Crush in the Anchor Scenario…PRA house prices, % change yr ago

Source: Moody’s Analytics

3737

-12-10

-8-6-4-202468

10

U.K.

U.S.

Germany

Spain

… Retail Sales Decline Initially…PRA retail sales, % change yr ago

Source: Moody’s Analytics

3838

5

10

15

20

25

30

35Euro zone Germany Spain

… Unemployment Rises RisePRA unemployment rate, %

Source: Moody’s Analytics

3939

2

4

6

8

10

12

14

16

18Europe North AmericaEuro zone WorldLatin America Developed AsiaDeveloping Asia

CCAR UnemploymentCCAR unemployment rate, %

Source: Moody’s Analytics

40

Financial Markets and Credit Risk8

4141

» Modelling of the term structure of Government yields. » Modelling of the term structure of swap rates. » Modelling of the term structure of corporate yields (or spreads to

government yields) by ratings. » Modelling of 5-year sovereign CDS indices. » Modelling of rating migration matrices of global issuers of bonds

rated by Moody’s Investors Service. » Return and volatility modelling of stock indices traded on the major

global exchanges. » Return and volatility modelling of major bilateral spot foreign

exchange rates. Decomposition of GDP into components.» Moody’s CreditCycle™ for econometric models

Market Variables and Credit Risk

4242

Financial Models: PRA U.K. Swap Rate Curves

42

Time-series of specific maturities for GBP swap ratesHistory and forecasts, baseline and anchor scenarios

4343

Financial Models: CCAR U.K. Swap Rate Curves

43

Time-series of specific maturities for GBP swap ratesHistory and forecasts, CCAR Baseline, Severe, and Severely Adverse scenarios

44

Concluding Remarks9

4545

» U.K. Stress Testing Framework evolving to a more granular, frequent and rigorous approach (FDSF)

» M.A. Scenario development: “map” the scenario assumptions to a large number of global macro, market, and credit factors (inputs into the ST framework).

» PRA 2014: Delivery in 5 business days.

Summary

Q&A Session

Please send your questions to help@economy.com

4646

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global economy please visit

www.economy.com

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4848

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