Summary of Stress Test Results as at September 2019
The Bank conducts stress tests on the banking sector to assess the resilience of banks to plausible credit and liquidity risk shocks, among others. The credit risk test focuses on the impact of non-performing loans shock on the level and adequacy of a bank’s capital. Meanwhile, the liquidity risk test covers both sides of the balance sheet to determine the level of available unencumbered liquid assets that could be used to meet near term payment obligations when faced with loss of funding or drying lines of credit. The aim of the liquidity stress test is to assess the ability of a bank to survive unexpected liquidity drain without recourse to any outside liquidity support, such as the central bank or inter-bank market. Overall, the tests assess the resilience of banks when subjected to moderate shocks as well as severe shocks, where the condition of the banking industry as at September 2019 serves as the baseline scenario.
Generally, the banking sector was adequately capitalised, liquid and profitable in September 2019, but banks breach the prudential limit when subjected to credit shocks. Specifically, banks breach the 15 percent prudential capital adequacy limit, at 9.8 percent, when 10 percent of performing loans become non-performing (moderate scenario).
The capital adequacy ratio declines to 6.1 percent under the severe scenario – where 15 percent of performing loans become non-performing. The ratio of NPLs to total loans increases to 14.7 percent in the moderate scenario and 19.4 percent in the severe scenario, from a baseline of 5.2 percent. Regarding liquidity stress tests, banks are generally resilient to liquidity shocks, with deposit run simulations showing a survival period of 26 days for large banks and 18 days for small ones in the moderate scenario. Large banks survive for 18 days in the severe scenario, while small banks survive for 12 days. The model assumes that a perfect asset-liability match leads to 30 days survival period.
The moderate scenario for the liquidity test applies relatively lower haircuts and run-off rates than the severe scenario, where haircuts are discounts on asset values, and run-off rates are the proportion of the value of a liability that has to be met immediately. The liquidity test results show that large banks have a higher chance of surviving a bank run compared to small banks in both the moderate and severe scenarios.
These scenarios do not take into account potential liquidity interventions by the Bank of Botswana. Therefore, results should not be interpreted to mean that the banks would default under these scenarios. Banks are not overly susceptible to interest rate risk. The banking sector would still operate with adequate capital levels under the moderate and severe interest rate shocks, where a moderate shock assumes a 150 basis points policy rate cut and a severe shock assumes a 350 basis points cut.
|(Conditions as at September 2019)||Capital Adequacy Ratio (CAR) of 18.6 percent.||Perfect Asset Liability match, leading to 30 days survival.||Banks start off with a CAR of 18.6 percent.|
|5.2 percent NPLs/Total loans.|
|Moderate Scenario:||10 percent of Performing loans become Non-Performing.||Bank run simulation based on Assets’ Hair-cuts and Liabilities’ Run-off Rates.||150 basis point cut in Policy Rate.|
|Large banks survive 26 days.|
|Banking system breaches the prudential limit with CAR of 9.8 percent.||Small banks survive 18 days.||18.2 percent CAR (change in CAR not significant at -0.4 percentage points).|
|NPLs/Total Loans ratio increases to 14.7 percent, a sign of increasing vulnerability.||Loss of P158.4million in interest income.|
|Description of Shock||15 percent of previously performing loans become non-performing.||Bank run simulation based on higher Assets’ Hair-cuts and Liabilities’ Run-off Rates than in moderate scenario.||350 basis points cut in policy rate.|
|Large banks survive 18 days.|
|Small banks survive 12 days.|
|Banking system breaches the prudential limit with CAR of 6.1 percent.||18 percent CAR (change is -0.6 percentage points).|
|Loss of P369.4 million in interest income.|
|NPL/Total Loans ratio increases to 19.4 percent, a sign of increasing vulnerability.|