The variables connecting the two VARs are interest rates and the exchange rate. The Austrian Central Bank, in its Systemic Risk Monitor (SRM), employs for adverse scenario building a pure statistical methodology based on the copula approach. The Albanian, Croatian, Greek and Slovenian Central Banks use a judgmental approach, by expertly setting the macroeconomic variables’ deviations from the baseline scenarios. The Central Banks of Serbia and Bosnia & Herzegovina follow the IMF adverse scenarios guidelines which feature a negative GDP growth both for the EU and the country, and FX risk (Serbia) and an increase in the country risk premium (Bosnia and Herzegovina). The Bulgarian Central Bank considers two different adverse scenarios based on judgmental assessment regarding the deterioration of loan portfolios quality. The Central Banks of Kosovo and Macedonia use mainly judgmental analysis<sup>11</sup> in their stress-testing assessments. Shocks related to developments in interest rates, exchange rates, the quality of loan portfolios and the extent of deposit withdrawals are expertly set.

# **4. Risk Factors**

The second step of a stress-testing process comprises identification and quantification of risk factors. Financial sectors encounter several types of risks, namely the credit risk, the market risk, the liquidity risk, the contagion risk, the business risk<sup>12</sup> , and the operational risk<sup>13</sup> . Each central bank tends to identify and focus on country-specific risk factors. As the main and most complex risk attached to a banking sector, the credit risk is assessed by all CSEECBs. In addition, central banks in Albania, Austria, Bulgaria, Croatia, the Czech Republic, Greece, Kosovo, Macedonia, Montenegro, Romania, Serbia, and the Slovak Republic examine the market risk, in particular the effect of exchange rate and interest rate changes on a bank’s financial condition. The liquidity risk is assessed by the central banks of the Czech Republic (the model-based approach), and of Albania, Austria, Hungary, Kosovo, Macedonia, and Montenegro (the judgmental analysis approach). The contagion risk analysis is performed by the central banks of Austria, the Czech Republic, Romania, and the Slovak Republic. We discuss the risk factors for the individual types of risks next along with the mapping from the macroeconomic scenarios to the respective risk factors.

## **4.1. Credit Risk Factors**

The credit risk is associated with the quality of loan portfolios. It is typically expressed in terms of loan performance, hence the main measures of the credit risk are: (1) the nonperforming loans (NPL, LLP and respective migration rates) and (2) probabilities of default (PDs) and loss-given-default (LGDs) and correlation of asset performance for individual credit portfolio components. Under the assumption that the loan quality is sensitive to the economic cycle (Foglia, 2009) these credit risk measures are estimated through the business cycle and cross-country benchmarks are available for instance from the QIS and Moody’s (Basel Committee on Banking Supervision, 2006; Moody’s, 2009).

> 11 The presentations often refer to judgmental analysis as “sensitivity analysis”.

> 12 The business risk relates to the identification of risk factors that could affect banks market shares (for instance, product origination practices, pricing policy, and funding strategy).

> 13 The operational risk relates to the increased probability of frauds in crisis times.

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