Annual Update - Stress Testing in the Capital Assessment and Risk Profile (CARP) for Bermuda's Banking Sector 2018

Summary

This is the Bermuda Monetary Authority's 2018 annual update to its Capital Assessment and Risk Profile (CARP) stress testing guidance for Bermuda's banking sector. It supplements (rather than replaces) the BMA's April 2014 stress testing guidance, setting out revised assumptions, templates and reporting requirements banks must apply for the 2018 CARP submission.

• Residential mortgages: Current LTVs must reflect a historical post-2008 average decline of 35% before applying additional standardised shocks of 10% and 20%; past due loans and troubled debt restructures must be excluded from the LTV template; liquidation cost assumptions must be realistic and no less than 10%.
• Commercial mortgages: Class B or lower buildings require a 30% valuation shock; other commercial mortgages require a 20% shock; reporting must show cumulative LTV erosion and realistic liquidation costs.
• Capital reconciliation: Banks must reconcile CET1 reported in the PIR (consolidated) to the amount reported in the stress testing template (Table 1).
• Investments: CUSIP or other common identifiers are required for all investments where available; a completed investment template (bonds and other claims) with balance, duration, PD and credit spread is required, using a credit spread shock.
• Interest Rate Risk in the Banking Book (IRRBB): Banks must report IRRBB using internally developed parameters, independently validate internal models using an External Expert Assessor (EEA), and comply with Basel IRRBB standards referenced in the Authority's Basel III guidance (paragraphs 30 to 33).
• Risk weighting floors: RWA computations must apply floors of 50% for performing residential mortgages, 100% for performing commercial mortgages, 150% (or 100% if LTV is 80% or less) for past due loans, and 100% for performing TDRs.
• Templates and reconciliation: Templates 1 to 3 in Appendix I must be submitted with a full reconciliation to the Q4 2017 Prudential Information Return (PIR) on both a Consolidated and Solo basis, alongside the CARP submission.
• Financial projections: Banks reporting a capital deficit under the stress scenario must provide three years of projected regulatory capital and retained earnings (Tables 2 and 3), consistent with their business plan, on both solo and consolidated bases.

The guidance also lists suggested macroeconomic drivers (unemployment, real estate price decline, reduced rental income, reduced personal/corporate income, tourism decline) that banks should translate into portfolio-specific shocks, and reiterates a minimum CET1 ratio target of 7.0% for determining capital shortfalls under stress.

Key obligations

• Submit Templates 1-3 (Appendix I) together with a full reconciliation to the Q4 2017 PIR on both a Consolidated and Solo basis as part of the 2018 CARP submission.
• Apply a 35% historical average LTV decline to current residential mortgage LTVs before applying additional 10% and 20% standardised shocks.
• Exclude past due loans and troubled debt restructures from the residential LTV template (Template 1).
• Apply a 30% valuation shock to Class B or lower commercial buildings and a 20% shock to other commercial mortgages.
• Use realistic liquidation cost assumptions (no less than 10% for residential mortgages) including maintenance, taxes, real estate commissions and legal fees.
• Provide a complete reconciliation from CET1 reported in the PIR (consolidated) to the amount reported in the stress testing template.
• Provide CUSIP or other common identifiers for all investments where available and complete the investment template for bonds and other claims, including credit spread shocks.
• Independently validate internal IRRBB models using an External Expert Assessor and submit the EEA's full validation report with or ahead of the CARP submission.
• Comply with Basel IRRBB standards on interest rate shocks and stress scenarios as set out in the Authority's Basel III guidance, paragraphs 30 to 33.
• Apply prescribed RWA risk-weighting floors for performing residential mortgages, commercial mortgages, past due loans and TDRs.
• Provide three years of projected regulatory capital (Table 2) and retained earnings (Table 3) for banks reporting a capital deficit under the stress test, on solo and consolidated bases.
• Provide detailed analysis of how macroeconomic parameters translate into specific shocks to individual portfolios as part of the stress testing exercise.

Applies to

banks

Deadlines

• Q4 2017: Templates 1-3 must be submitted with a full reconciliation to the Q4 2017 Prudential Information Return (PIR) on both a Consolidated and Solo basis.
• with the CARP submission: All required templates, information, and the EEA's IRRBB validation report should be submitted at the same time as (or ahead of) the CARP submission.