Risk-to-Buffer: Setting Cyclical and Structural Capital Buffers through Banks Stress Tests

In this work we present the Risk-to-Buffer: a new framework to jointly calibrate cyclical and structural capital buffers, based on the integration of a non-linear macroeconomic model with a Stress test model. The macroeconomic model generates scenarios whose severity depends on the level of cyclical risk. Risk-related scenarios feed into a banks' Stress test model. Banks' capital losses deriving from the reference-risk scenario are used to calibrate the structural buffer. Additional losses associated to the current-risk scenario are used to calibrate the cyclical buffer.