Commercial real estate firms constitute the single largest risk of credit losses for banks in a stressed scenario. However, other sectors’ total loss contribution in such scenario is equally large. This is the conclusion of a new analysis by Finansinspektionen (FI) of how banks’ credit losses could be impacted by a macroeconomic shock.
The analysis presents a new method for stress testing how vulnerabilities in non-financial firms could impact banks’ credit losses following a macroeconomic shock. The method makes it possible to assess in more detail the link between these firms’ financial position and banks’ credit risks in order to be able to assess the banks’ resilience if the economy were to experience a sharp downturn.
“Non-financial firms make up a large portion of banks’ lending. If a significant share of these firms were to experience payment difficulties, this could pose a risk to the stability of the financial system. Our analysis shows that commercial real estate firms represent the largest share of the credit losses in a stressed scenario, but that other sectors together contribute just as much. The credit risks are thus spread throughout the economy and are not limited to a specific sector,” says Jon Thor Sturluson, Chief Economist at FI.
The stress test is based on simulations of non-financial firms’ profit and loss statements, balance sheets, and cash flows. The analysis shows how major changes in GDP, inflation, interest and asset prices impact the firms’ financial position and thus their credit assessment. This change is then linked to both the classification of the firms’ loans according to the IFRS 9 accounting standard and the impact on the banks’ credit loss reserves.
The method can be used as a tool to analyse risks and vulnerabilities in the corporate sector and its link to the financial sector as well as a complement to other models that FI uses in its analysis and supervision of banks’ credit risks.
