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FRM Part II · FRM Exam Part II · Stress Testing Banks

The EU-wide stress test coordinated by the European Banking Authority (EBA) is often described as a constrained bottom-up exercise. What does this mean?

A constrained bottom-up exercise means banks run the projections with their own models, but within a common methodology, shared scenarios and set constraints, such as a static balance sheet. Supervisors then challenge and quality-assure the results to keep outcomes comparable across banks.

  1. ABanks compute projections using their own models, but must follow a common methodology, scenarios and constraints, and results are challenged by supervisorsCorrect
  2. BSupervisors run all models centrally, and banks provide no inputs
  3. CBanks freely choose scenarios and methodologies, with no supervisory challenge
  4. DOnly the largest bank in each country participates and uses top-down assumptions

Explanation

In the EBA approach, banks produce the projections but within a common methodology, with constraints such as static balance sheet and floors, and supervisors quality-assure the results. This differs from the Fed's primarily top-down supervisory models.

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