Stress-Testing Net Trading Income: The Case of European Banks

35 Pages Posted: 5 Mar 2021 Last revised: 10 Dec 2021

See all articles by Carla Giglio

Carla Giglio

European Central Bank (ECB)

Frances Shaw

European Central Bank (ECB)

Nicolas Syrichas

Goethe University Frankfurt

Giuseppe Cappelletti

European Central Bank (ECB)

Date Written: February, 2021

Abstract

Net trading income is an important but volatile source of revenue for many euro area banks deemed to be highly sensitive to changes in financial market conditions. We propose a two-step econometric approach to quantify the downside risk of financial shocks on the banks’ trading revenues. First, we estimate the parameters of a fixed-effects quantile autoregressive model conditional on exogenous macro-financial shocks and bank characteristics. In the second step, we approximate the entire empirical conditional distribution of net trading income across all banks and time horizons by interpolating between the estimated quantiles. Based on the estimated distribution function, we derive two key metrics that summarize conditional left tail risks: i) conditional shortfall, ii) material loss probability. These measures are relevant in a stress test exercise whose aim to gauge CET-1 capital depletion under an adverse macro-financial scenario. We apply our methodology on supervisory data for a representative sample of European banks over the period spanning from the first quarter of 2015 to the last quarter of 2020. We find that the lower quantiles of net trading revenue distribution are significantly impacted by deteriorating financial conditions, whereas the upper quantiles seem to be stable over time.

Keywords: capital shortfall, net trading income, quantile panel regression, stress testing

JEL Classification: C21, C23, G21, G28

Suggested Citation

Giglio, Carla and Shaw, Frances and Syrichas, Nicolas and Cappelletti, Giuseppe, Stress-Testing Net Trading Income: The Case of European Banks (February, 2021). ECB Working Paper No. 2021/2525, Available at SSRN: https://ssrn.com/abstract=3797145

Carla Giglio (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Frances Shaw

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Nicolas Syrichas

Goethe University Frankfurt ( email )

Grüneburgplatz 1
Frankfurt am Main, 60323
Germany

Giuseppe Cappelletti

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
34
Abstract Views
166
PlumX Metrics