inform our macro - financial scenario design. second, a benchmark parameter block. the macro - financial scenario will in turn affect the banking sector through a number of channels including the impact on banks ’ credit portfolios, their trading book and the various components of profits. in practice, this transmission is performed via a number of satellite models. the impact is three - fold, affecting credit risk, market risk and bank profitability. our efforts so far have focused on deriving properly modelled credit risk parameters ( that is, probabilities of default and loss - given - default rates from which loss rates are calculated ). we have invested heavily in this area because credit risk still is the main risk component for most european banks. regarding market risk, the benchmark parameter calibration techniques we have developed have mostly concerned the computation of haircuts on banks ’ sovereign debt holdings. ( this uses a model that was specifically constructed for and used in the last two eba eu - wide stress testing exercises. ). finally, regarding the modelling of bank profitability, we currently focus much of our efforts on simulating net interest income, because this remains the most important profit component for the majority of eu banks. other items affecting bank earnings, such as trading income, fees and commissions, taxes and dividend policies, are generally based on judgemental assumptions or extrapolations. third, the balance sheet part of the framework. this third module includes models to estimate loan losses and tools to simulate banks ’ balance sheet items ( accounting and regulatory ) as well as their profit and loss statements to calculate the impact on banks ’ capitalisation. as the modelling framework is based on a bank - by - bank assessment of individual banks ’ balance sheets, it is flexible with respect to the geographical coverage in the eu or euro area. fourth, contagion and feedback effects. typically, stress tests ( including the eba eu - wide exercise ) do not look beyond the first - order impact on banks ’ solvency positions. however, identified capital shortfalls likely have repercussions beyond such immediate effects at the individual bank level. hence, our fourth building block, which is still the least developed, concerns the modelling of contagion from banks failing the stress test to other banks ( via various forms of counterparty exposure ) and, more broadly, also to other economic sectors ( using a flow - of - funds - based propagation tool ). in addition, real economic feedbacks are modelled via reductions in loan supply

such concepts are still at a relatively early stage, and i look forward to them being developed further in the next few months. conclusion let me now conclude. as i have explained, the euro area has taken important steps to restore stability. but we now need to build on those foundations to create higher growth and employment. the good news is that we understand the challenges we face : to strengthen emu ; to ensure sustainable policies ; to improve competitiveness. and to meet these challenges, we can look to several countries for examples. but the key is to persevere on the path of reform – and to take inspiration from others that are succeeding. within the euro area, we all benefit from each other ’ s prosperity. i hope that bis central bankers ’ speeches the range of businesses from across the euro area here today will join me in spreading this message. thank you for your attention. bis central bankers ’ speeches