Stress Test 2025

Stress Test 2025 has now been published on the Central Bank of Iceland website. This is its first release as a separate report, whereas the topic was previously covered in the autumn issue of Financial Stability. Stress Test 2025 presents the results of the Bank's stress test, compares them to the results of the European Banking Authority's stress test, and examines the Bank's model for credit growth and its interaction with the real economy.

The Central Bank of Iceland's stress test indicates that the three systemically important banks O-SII are resilient enough to maintain the supply of credit and support the economy during a severe shock. The shock described in the stress test is based on hypothetical but severe events centring on heightened geopolitical tensions and an escalation of war. These events lead to a contraction in GDP, a rise in unemployment, and a steep decline in asset prices.

The Central Bank estimates that in the scenario presented, the O-SIIs' loan losses would equal 145 b.kr., or 3.3% of the claim value of the loan portfolio at the time the test began. Loan losses are offset by the D-SIBs' strong core operations, so that their after-tax losses total 13 b.kr. in the most difficult year of the stress scenario.

The ratio of common equity Tier 1 (CET1) capital to the risk base declines by 1.3 percentage points from the beginning of the scenario to the trough. Overall capital requirements and CET1 capital requirements are satisfied in all years of the horizon. Based on the results of the stress test, it is unlikely that the O-SIIs would have to significantly curtail the supply of credit in response to the shock. In other words, it is considered unlikely that the banks would have to cut back on lending to strengthen their capital ratios, which would cause an even deeper economic contraction.

For the first time, the assumptions underlying the Central Bank's stress scenario are comparable to those used by the European Banking Authority (EBA) in its stress test of 64 European banking conglomerates. A comparison reveals that Icelandic banks' capital and leverage ratios decline only modestly in comparison with those of the European banks. This is due, among
other things, to the Icelandic banks' higher leverage ratio and their relatively limited market risk. The results are positive, but it should be borne in mind that the Icelandic economy is smaller and is exposed to various risks.

In the Stress Test 2025 report the following six boxes can be found, as well as an overview of previously published boxes.