Luxembourg: Financial Sector Assessment Program—Technical Note on Stress Testing and Systemic Risk Analysis

LUXEMBOURG IMFCountryReportNo.24/185 June2024 FINANCIALSECTORASSESSMENTPROGRAM TECHNICALNOTEONSTRESSTESTINGANDSYSTEMICRISKANALYSIS ThisTechnicalNoteonStressTestingandSystemicRiskAnalysisfortheLuxembourgFSAPwaspreparedbyastaffteamoftheInternationalMonetaryFundasbackgrounddocumentationfortheperiodicconsultationwiththemembercountry.ItisbasedontheinformationavailableatthetimeitwascompletedonJanuary2024. Copiesofthisreportareavailabletothepublicfrom InternationalMonetaryFundPublicationServicesPOBox92780Washington,D.C.20090Telephone:(202)623-7430Fax:(202)623-7201 E-mail:publications@imf.orgWeb:http://www.imf.orgPrice:$18.00perprintedcopy InternationalMonetaryFundWashington,D.C. ©2024InternationalMonetaryFund May31,2024 LUXEMBOURG FINANCIALSECTORASSESSMENTPROGRAM TECHNICALNOTE STRESSTESTINGANDSYSTEMICRISKANALYSIS ThisTechnicalNotewaspreparedbyIMFstaffinthecontextoftheFinancialSectorAssessmentPrograminLuxembourg,ledbySrobonaMitra.ItcontainstechnicalanalysisanddetailedinformationunderpinningtheFSAP’sfindingsandrecommendations.FurtherinformationontheFSAPcanbefoundathttp://www.imf.org/external/np/fsap/fssa.aspx PreparedBy MonetaryandCapitalMarketsDepartment CONTENTS Glossary5 EXECUTIVESUMMARY7FINANCIALSYSTEMSTRUCTUREANDINTERCONNECTEDNESS10 A.InvestmentFunds11 B.BankingSector15 C.InsuranceSector18 D.CaptiveFinancialInstitutionsandMoneyLenders21 E.Interconnectedness23 STRESSTESTSTRATEGY25 A.FSAPStressTestingandMethodology25 B.FinancialMarketShocks(FirstRound)27 C.MacrofinancialScenario—BaselineandAdverse(FirstRound)28 D.MarketContagionandLiquidity-SolvencyInterationsEffects(SecondandThirdRounds)33 BANKSOLVENCYSTRESSTESTS33 A.TypesofStressTests33 B.BankingSectorSolvencyStressTestResults35 C.ResultsofSensitivityAnalysis45 BANKLIQUIDITYSTRESSTESTS48 A.Methodology48 B.Results51 LIQUIDITYSTRESSTESTFORINVESTMENTFUNDS57 A.ObjectiveandScope57 B.Methodology58 C.Results61 MONEYMARKETFUNDSSTRESSTESTS68 A.ObjectiveandMethodology68 B.Results69 INSURANCESOLVENCYSTRESSTEST71 A.ScopeandSampleoftheSolvencyStressTest71 2INTERNATIONALMONETARYFUND B.ScenariofortheSolvencyStressTest72 C.CapitalStandardandModelingAssumptions75 D.ResultsoftheSolvencyStressTest76 E.SensitivityAnalyses79 INSURANCELIQUIDITYANALYSIS81 A.ApproachandScopefortheLiquidityRiskAnalysis81 B.ResultsoftheLiquidityRiskAnalysis82 References114 FIGURES 1.FinancialSectorSizeComparedtotheU.S.andtheEuroArea122InvestmentFunds’MarketSharebyTypeofStructureandStrategy13 3.StockofInvestmentFunds’DirectCREInvestmentsbyCountry14 4.InvestmentFunds—NetRedemptionsandChangeinAssets15 5.BanksbyBusinessModel16 6.BankingSectorBalanceSheet17 7.InsuranceMarketStructure20 8.CaptiveFinancialInstitutionsandMoneyLenders22 9.Interconnectedness24 10.StressTestStrategy27 11.FinancialShockCalibration28 12.ScenarioSeverityfromaHistoricPerspective31 13.MacroeconomicBaselineandAdverseScenarios32 14.StackingOrderforOverallCapitalRequirement/MaximumDistributableAmount34 15.DistributionofBanks’ExposuresbyAssetClass(asaPercentofTotalAssets)36 16.PDProjectionsintheBaselineandAdverseMacroeconomicScenarios38 17.BankSolvencyStressTestResults42 18.BankSolvencyStressTestResults:BreakdownBetweenDomestically-OrientedandInternationally-OrientedBanks43 19.BankLiquidity-SolvencyInteractions45 20.SensitivityAnalysesforSovereignandCreditConcentrationRisks46 21.BankNSFRStressTestResults51 22.BankLCRComponentsandStressTestResults52 23.SensitivityofLCRstoDepositRun-OffRates53 24.Cash-FlowBasedAnalysisResults54 25.InvestmentFunds’HQLADistributionbyStrategy60 26.InvestmentFunds—AssetExposures61 27.NetOutflowsUnderDifferentScenarios63 28.PriceImpactofAssetSalesforSelectedAssetGroups65 29.InvestmentFunds’ReverseLiquidityStressTestResults67 30.MMFStressTestResults—BoxplotswithFallinNAVbyTypeofMMF70 31.MMFReverseStressTestResults71 32.InsuranceSolvencyStressTest—ValuationImpact77 33.InsuranceSolvencyStressTest—SolvencyImpact79 34.InsuranceSensitivityAnalyses80 35.LifeInsuranceLapseRates82 36.LifeInsuranceRedemptionShock83 TABLES 1.2024FSAP:KeyRecommendations9 2.Banks’FinancialSoundnessIndicators(BasedontheStressTestSample)19 3.StressTestAverageHurdleRatiosvs.CurrentRatios34 4.ComparisonBetweenMacroScenarioProjectionsandSensitivityTestAssumptions35 5.BankSolvencyStressTestResults:BreakdownbyBusinessModel43 6.Cash-FlowBasedStressTestsOutflowRatesfromDeposits,Liquidity,andCreditLines49 7.Cash-FlowBasedStressTests—HaircutsonCounterbalancingCapacity50 8.LCRStressTestParameters50 9.SummaryofBankLiquidityStressTestResults56 10.InvestmentFundStressTestSample—StatisticsbyFundType58 11.EstimatedInitialChangeinNAVFollowingAdverseandGFCScenarios62 12.EstimatedFinalChangeinNAVFollowingAdverseScenario65 13.ResultsoftheInvestmentFundLiquidityStressTest66 14.MoneyMarketFunds—StatisticsbyFundType69 15.InsuranceStressTestSample72 16.InsuranceStressTestSpecification74 APPENDICES I.RiskAssessmentMatrix84 II.StressTestMatrix85 III.SummaryResultsoftheStressTestsAcrossSectors92 IV.TechnicalDetailsontheStressTestAdverseScenarioCalibration93 V.Method