Banks urge EBA to delay risk benchmarking amid Iran conflict – Risk.net

European banks are requesting a delay in submitting results for the European Banking Authority’s (EBA) annual market risk benchmarking exercise, citing the significant disruption caused by escalating geopolitical tensions in the Middle East. Risk managers at three banks confirmed the requests, arguing that the current market turbulence clashes with the hypothetical nature of the portfolio exercise.

An EBA spokesperson acknowledged receiving the requests and stated the authority is currently reviewing them with the relevant supervisory subgroup. The benchmarking exercise, designed to assess banks’ market risk models, requires institutions to report their exposures and risk calculations based on a standardized portfolio.

The Benchmarking Challenge

The core issue, according to sources familiar with the discussions, is the difficulty of applying hypothetical portfolio stress tests when real-world market conditions are already exhibiting extreme volatility. The outbreak of hostilities in the Middle East has triggered sharp movements in energy prices, currency fluctuations, and increased risk aversion across asset classes. Banks argue that the exercise, intended to evaluate model accuracy, is rendered less meaningful when actual market events are far exceeding the scenarios considered in the benchmark.

The EBA’s annual benchmarking process is a key component of its broader efforts to enhance the resilience of the European banking sector. It aims to identify weaknesses in banks’ risk management practices and promote convergence in modeling approaches. The exercise typically focuses on market risk, specifically the risk of losses arising from movements in market prices. Banks are required to calculate their exposures to various risk factors, such as interest rates, credit spreads, and equity prices, and then assess the impact of different stress scenarios on their capital positions. Risk.net reports that the results are used by the EBA to inform its supervisory priorities and to identify areas where further regulatory action may be needed.

Geopolitical Risk and Regulatory Focus

The request for a delay comes amid growing concerns about the impact of geopolitical risks on the financial system. The EBA, in a recent statement, emphasized the need for banks to strengthen their resilience to geopolitical shocks. Euromoney reported that the EBA urged banks to focus on geopolitical risk, highlighting the potential for disruptions to supply chains, energy markets, and financial flows.

The International Swaps and Derivatives Association (Isda) has also been actively monitoring the situation, providing guidance to its members on the legal and operational implications of sanctions and other measures imposed in response to the conflict. Isda’s role is crucial in ensuring the smooth functioning of the derivatives markets, which are heavily used by banks to hedge their risks.

Capital Requirements and Market Turbulence

The timing of the EBA’s benchmarking exercise is particularly sensitive given the ongoing debate about the calibration of capital requirements for banks. The Capital Requirements Directive (CRD) sets out the rules for how much capital banks must hold to cover their risks. Regulators are currently considering proposals to revise the CRD, with some advocating for higher capital requirements to enhance the stability of the banking system.

Banks are wary of any changes that could increase their capital costs, especially in the current environment of heightened market volatility. They argue that excessive capital requirements could stifle lending and economic growth. The benchmarking exercise results could potentially influence the debate over capital requirements, as they provide insights into the accuracy and consistency of banks’ risk models.

What Happens Next

The EBA’s decision on whether to grant a delay will be closely watched by the banking industry. If the EBA agrees to postpone the submission of results, it could provide banks with some breathing room to reassess their risk models and incorporate the latest market developments. However, a delay could also raise questions about the credibility of the benchmarking exercise and its ability to provide a timely assessment of banks’ risk management practices.

Regardless of the outcome, the current situation underscores the growing importance of geopolitical risk in financial stability assessments. Banks will need to continue to strengthen their resilience to geopolitical shocks and to enhance their ability to manage risks in a rapidly changing world. The EBA is expected to provide further guidance on this issue in the coming months, potentially through updates to its supervisory framework or through targeted reviews of banks’ risk management practices.