The Central Bank of Iceland’s capital stress tests
The Central Bank of Iceland conducts annual stress tests to assess the resilience of systemically important banks (O-SII) against a variety of shocks. Assessing the effects of these shocks enhances understanding of O-SIIs‘ overall risk sensitivity and the significance of individual risk factors.
The shocks are presented as comprehensive stress scenarios that cover the real economy and asset markets. The scenarios draw on the latest assessments of cyclical systemic risk at any given time and on lessons from previous stress tests and other analyses of O-SIIs’ operations and financial position. The scenarios are not forecasts of likely developments but rather descriptions of severe but plausible developments that are intended to test O-SIIs’ resilience.
The stress scenarios are presented as narrative descriptions of the main assumptions and causes that are assumed to lead to the shock. They are accompanied by a spreadsheet containing key economic variables and developments in asset prices and funding costs in the scenario. It should be noted that the stress scenarios are focused on banking, which, among other things, is reflected in the choice of risk factors that are in focus and the selection of economic variables that are presented, as well as their duration and frequency.
Each year’s stress test is based on the previous year-end position of the O-SIIs, using data collected through the O-SIIs’ regular supervisory reporting as well as specific data requested for stress testing purposes. The results of the stress test are generally assessed by both the Bank and the O-SIIs. The Bank has several statistical models that are based on micro and macro data, as required. The O-SIIs are generally required to produce their own results using their own models and expert judgement, which they can utilise in their operations and in discussions and conversations with the Bank about the scenarios’ effects.
The Bank has published the results of stress tests regularly since 2015, in accordance with its legally mandated role pursuant to Article 80, Paragraph 7 of the Act on Financial Undertakings, no. 161/2002. The results were published in the Central Bank’s Financial Stability report until 2024. From 2025 the results have been published in the Bank’s Stress Test report, which can be found here.
The results of stress tests are used in multiple ways, including in the estimation of the positive neutral countercyclical capital buffer rate, as is stated in the Criteria for the determination of the countercyclical capital buffer. The results can also be used in other discussions on the use of macroprudential measures and assessments of financial sector resilience carried out by external parties such as international institutions and credit rating agencies.