Chapter 6. Of Runes and Sagas: Perspectives on Liquidity Stress Testing Using an Iceland Example

Abstract

The global financial crisis revealed weaknesses in the stress testing exercises performed on financial institutions and systems around the world. These failures were most evident in the area of liquidity risk, where now obvious vulnerabilities were left largely undetected, with stress tests having largely focused on solvency risk. This study uses publicly available data from a now defunct bank in Iceland, where liquidity shocks were immense, to demonstrate how a combination of stress tests of the various risks would have provided a clearer picture of existing vulnerablities. We show that, ultimately, stress test models do not necessarily need to be complex or overly sophisticated. Basic stress tests, using appropriate assumptions and shocks, could reveal key areas of vulnerability to inform contingency planning.

Contributor Notes

This chapter was previously published as IMF Working Paper 10/156 (Ong and Čihák, 2010). The authors would like to thank Sean Craig, Mark Flanagan, Daniel Hardy, Michael Hsu, and participants at an internal IMF seminar for their useful comments; and Guðrún Ögmundsdóttir at the Seðlabanki for her very helpful input.
Author: Ms. Li L Ong