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

FINANCIALSECTOR ASSESSMENT PROGRAM TECHNICAL NOTE ONSTRESS TESTING ANDSYSTEMIC RISK ANALYSIS ThisTechnical Note onStress Testing and Systemic Risk Analysisfor theLuxembourgFSAPwas prepared by a staff team of the International Monetary Fundas backgrounddocumentation for the periodic consultation with the member country. It is based on theinformation available at the time it was completed onJanuary2024. Copies of this report are available to the public from International Monetary Fund•Publication ServicesPO Box 92780•Washington, D.C. 20090Telephone: (202) 623-7430•Fax: (202) 623-7201E-mail:publications@imf.org Web:http://www.imf.orgPrice: $18.00per printed copy International Monetary FundWashington, D.C. LUXEMBOURG FINANCIAL SECTOR ASSESSMENT PROGRAM TECHNICAL NOTE STRESS TESTING AND SYSTEMIC RISK ANALYSIS This Technical Note was prepared by IMF staff in thecontext of the Financial Sector Assessment Programin Luxembourg, led by Srobona Mitra. It containstechnical analysis and detailed informationunderpinning the FSAP’s findings andrecommendations. Further information on the FSAPcan be found athttp://www.imf.org/external/np/fsap/fssa.aspx PreparedBy Monetary and CapitalMarkets Department CONTENTS Glossary ____________________________________________________________________________________________5 EXECUTIVE SUMMARY ___________________________________________________________________________7 FINANCIAL SYSTEM STRUCTURE AND INTERCONNECTEDNESS ____________________________ 10 A. Investment Funds _____________________________________________________________________________ 11B. Banking Sector ________________________________________________________________________________ 15C. Insurance Sector_______________________________________________________________________________ 18D. Captive Financial Institutions and Money Lenders ____________________________________________ 21E. Interconnectedness____________________________________________________________________________ 23 STRESS TEST STRATEGY ________________________________________________________________________ 25 A. FSAP Stress Testing and Methodology ________________________________________________________ 25B. Financial Market Shocks (First Round) _________________________________________________________ 27C. Macrofinancial Scenario—Baseline and Adverse (First Round) ________________________________ 28D. Market Contagion and Liquidity-Solvency Interations Effects (Second and Third Rounds) ___ 33 BANK SOLVENCY STRESS TESTS _______________________________________________________________ 33 A. Types of Stress Tests __________________________________________________________________________ 33B. Banking Sector Solvency Stress Test Results __________________________________________________ 35C. Results of Sensitivity Analysis _________________________________________________________________ 45 A. Methodology__________________________________________________________________________________ 48B. Results_________________________________________________________________________________________ 51 LIQUIDITY STRESS TEST FOR INVESTMENT FUNDS __________________________________________ 57 A. Objective and Scope __________________________________________________________________________ 57B. Methodology __________________________________________________________________________________ 58C. Results_________________________________________________________________________________________ 61 A. Objective and Methodology __________________________________________________________________ 68B. Results_________________________________________________________________________________________ 69 A. Scope and Sample of the Solvency Stress Test ________________________________________________ 71 B. Scenario for the Solvency Stress Test__________________________________________________________ 72C. Capital Standard and Modeling Assumptions _________________________________________________ 75D. Results of the Solvency Stress Test____________________________________________________________ 76E. Sensitivity Analyses ____________________________________________________________________________ 79 INSURANCE LIQUIDITY ANALYSIS_____________________________________________________________ 81 A. Approach and Scope for the Liquidity Risk Analysis___________________________________________ 81B. Results of the Liquidity Risk Analysis __________________________________________________________ 82 References______________________________________________________________________________________114 FIGURES 1.Financial Sector Size Compared to the U.S. and the Euro Area ________________________________ 122 Investment Funds’ Market Share by Type of Structure and Strategy___________________________ 133. Stock of Investment Funds’ Direct CRE Investments by Country ______________________________ 144. Investment Funds—Net Redemptions and Change in Assets _________________________________