Title Page
A Guide to IMF Stress Testing
Methods and Models
Editor
Li Lian Ong
Copyright
©2014 International Monetary Fund
Cover design: IMF Multimedia Services Division
Cataloging-in-Publication Data
Joint Bank-Fund Library
A guide to IMF stress testing: methods and models / editor, Li Lian Ong. —
Washington, D.C.: International Monetary Fund, 2014.
p.; cm.
Includes bibliographical references and index.
1. Financial crises. 2. Banks and banking, International. 3. International Monetary Fund. I. Ong, Li Lian. II. International Monetary Fund.
HB3725.G84 2014
ISBN: 978-1-48436-858-9 (paper)
ISBN: 978-1-47555-129-7 (web PDF)
Disclaimer: The views expressed in this book are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
Please send orders to:
International Monetary Fund, Publication Services
P.O. Box 92780, Washington, DC 20090, U.S.A.
Tel.: (202) 623-7430 Fax: (202) 623-7201
E-mail: publications@imf.org
Internet: www.elibrary.imf.org
Frontmatter Page
For
Mark W. Swinburne
June 17, 1955–September 3, 2009
Assistant Director
Monetary and Capital Markets Department
International Monetary Fund
Manager, mentor, friend
Contents
Foreword
José Viñals
Acknowledgments
Abbreviations
Contributing Authors
-
1. Stress Testing at the International Monetary Fund: Methods and Models
Li Lian Ong • Martin Čihák
-
PART I THE ACCOUNTING-BASED APPROACH
A. THE BALANCE SHEET-BASED APPROACH
2. Introduction to the Balance Sheet-Based Approach to Stress Testing
Christian Schmieder • Liliana Schumacher
3. Stress Tester: A Toolkit for Bank-by-Bank Analysis with Accounting Data
Martin Čihák
4. Into the Great Unknown: Stress Testing with Weak Data
Li Lian Ong • Rodolfo Maino • Nombulelo Duma
5. Next-Generation Applied Solvency Stress Testing
Christian Schmieder • Claus Puhr • Maher Hasan
6. Of Runes and Sagas: Perspectives on Liquidity Stress Testing Using an Iceland Example
Li Lian Ong • Martin Čihák
7. Next-Generation Systemwide Liquidity Stress Testing
Christian Schmieder • Heiko Hesse • Benjamin Neudorfer • Claus Puhr • Stefan W. Schmitz
8. Systemic Bank Risk in Brazil: A Comprehensive Simulation of Correlated Market, Credit, Sovereign, and Interbank Risks
Theodore Barnhill Jr. • Marcos Souto
9. Modeling Correlated Systemic Bank Liquidity Risks
Theodore Barnhill Jr. • Liliana Schumacher
10. Review and Implementation of Credit Risk Models
Renzo G. Avesani • Kexue Liu • Alin Mirestean • Jean Salvati
11. Bankers without Borders? Implications of Ring-Fencing for European Cross-Border Banks
Eugenio Cerutti • Anna Ilyina • Yulia Makarova • Christian Schmieder
12. Conducting Stress Tests of Defined Benefit Pension Plans
Gregorio Impavido
B. THE NETWORK ANALYSIS APPROACH
13. Introduction to the Network Analysis Approach to Stress Testing
Marco A. Espinosa-Vega • Juan Solé
14. Cross-Border Financial Surveillance: A Network Perspective
Marco A. Espinosa-Vega • Juan Solé
15. Balance Sheet Network Analysis of Too-Connected-to-Fail Risk in Global and Domestic Banking Systems
Jorge A. Chan-Lau
PART II THE MARKET PRICE-BASED APPROACH
A. THE EQUITY INDICATORS-BASED APPROACH
16. Introduction to the Equity Indicators-Based Approach to Stress Testing
Jorge A. Chan-Lau
17. The Global Financial Crisis and Its Impact on the Chilean Banking System
Jorge A. Chan-Lau
18. Regulatory Capital Charges for Too-Connected-to-Fail Institutions: A Practical Proposal
Jorge A. Chan-Lau
B. THE EXTREME VALUE THEORY APPROACH
19. Introduction to the Extreme Value Theory Approach to Stress Testing
Srobona Mitra
20. External Linkages and Contagion Risk in Irish Banks
Elena Duggar • Srobona Mitra
21. Identifying Spillover Risk in the International Banking System: An Extreme Value Theory Approach
Jorge A. Chan-Lau • Martin Čihák • Srobona Mitra • Li Lian Ong
C. THE CONTINGENT CLAIMS ANALYSIS APPROACH
22. Introduction to the Contingent Claims Analysis Approach for Stress Testing
Dale F. Gray • Andreas A. Jobst • Cheng Hoon Lim • Yingbin Xiao
23. Vulnerabilities of Household and Corporate Balance Sheets in the United Kingdom and Risks for the Financial Sector
Marta Ruiz-Arranz
24. Measuring and Analyzing Sovereign Risk with Contingent Claims
Michael T. Gapen • Dale F. Gray • Cheng Hoon Lim • Yingbin Xiao
25. Factor Model for Stress Testing with a Contingent Claims Model of the Chilean Banking System
Dale F. Gray • James P. Walsh
26. Systemic Contingent Claims Analysis
Andreas A. Jobst • Dale F. Gray
27. Measuring Systemic Risk-Adjusted Liquidity
Andreas A. Jobst
PART III THE MACRO-FINANCIAL APPROACH
-
28. Introduction to the Macro-Financial Approach to Stress Testing
Andrea M. Maechler
29. A Macro Stress Test Model of Credit Risk for the Brazilian Banking Sector
Francisco Vazquez • Benjamin M. Tabak • Marcos Souto
30. A Practical Example of the Nonperforming Loans Projection Approach to Stress Testing
Torsten Wezel • Michel Canta • Manuel Luy
31. Portfolio Credit Risk and Macroeconomic Shocks: Applications to Stress Testing under Data-Restricted Environments
Miguel A. Segoviano • Pablo Padilla
32. Banking Stability Measures
Miguel A. Segoviano • Charles A. E. Goodhart
33. A Forward-Looking Macroprudential Stress Test for U.S. Banks
Geoffrey N. Keim • Andrea M. Maechler
34. The Real Effects of Financial Sector Risk
Alexander F. Tieman • Andrea M. Maechler
-
Index
TOOLKIT CONTENTS
The files listed below are available on the companion CD and at www.elibrary.imf.org/stress-test-toolkit.
Chapter 3
Stress Tester 3.0
Chapter 4
Excel Spreadsheet Macro for the Breaking Point Method
Chapter 5
Excel Spreadsheet Macro for the Next-Generation Solvency Stress Test
Chapter 6
Excel Spreadsheet Macro for the Market and Funding Liquidity Stress Test
Chapter 7
Excel Spreadsheet Macro for the Next-Generation Systemwide Liquidity Stress Test
Chapter 10
Excel Add-in for the CreditRisk+ Model
Chapter 12
Excel Spreadsheet Macro for Stress Testing Defined Benefit Pension Plans
Chapter 14
Excel-based Program for Bank Network Analysis
Chapter 20
Example Eviews Program Codes: External Linkages
Chapter 21
Example Eviews Program Codes: International Banking System
Chapter 24
Excel Spreadsheet for the Balance Sheet Risk Analysis
Chapter 33
Excel Spreadsheet Macro for Forward-Looking Macroprudential Stress Test
Foreword
The global financial crisis has placed a spotlight on the stress testing of financial systems. Although weaknesses in stress tests were exposed by the crisis, the recent experience of several countries has conversely provided a stark illustration of their potential benefit in examining the resilience of bank balance sheets when performed credibly and transparently. Nonetheless, the large menu of stress testing approaches, methods, and models raises questions about their appropriate application under different situations and, consequently, the comparability and reliability of the associated analyses.
The International Monetary Fund (IMF) has had a long and unique involvement in the stress testing of financial systems. Since the introduction of the Financial Sector Assessment Program (FSAP) more than a decade ago, IMF staff has conducted stress tests of banking sectors in over 120 countries, typically in close collaboration with country authorities. Stress testing is also playing an increasingly important role in the IMF’s multilateral surveillance, through the analysis in our Global Financial Stability Report. Separately, member countries are increasingly requesting IMF technical assistance in stress testing as they develop their own expertise in this area. As a result, our staff has amassed a wealth of hands-on experience with stress testing techniques and their practical application.
This book represents a compendium of stress testing methods, models, and tools developed or adapted by IMF staff over the years. Almost all the methods and models that are included in this volume have, at one time or another, been applied in our surveillance of, or our technical assistance to, member countries. To guide users, each chapter offers a summary describing the application of a method or model, its strengths and weaknesses, and the data requirements. Where available, the stress testing tools or program codes are also provided for wider public use.
Although I trust that this volume will provide a valuable resource for policymakers, supervisors, academics, and private sector participants alike, caveats still apply. The crisis has underscored that stress tests, irrespective of their level of sophistication, are not fail-safe, stand-alone diagnostic tools. Assessments of the soundness of any financial system cannot and should not be based solely on a “model” and must be complemented by other quantitative analyses, qualitative information, and, most important, expert judgment. Especially in light of evolving market practices, risks, and regulatory requirements, stress testing will necessarily continue to be art rather than science.
IMF staff is continually working to strengthen the analytical underpinnings of its stress testing, in ways that will help bolster its consistency and comparability and hence its credibility. Key areas of focus include extending the analysis to better cover nonbank financial institutions and infrastructures; to take account of spillovers between institutions and across borders; to consider the interaction between liquidity and solvency risks; and to address data gaps. In addition, IMF staff is developing the policy-related aspects of stress testing, namely, “best practice” principles, concepts, and frameworks, to complement and strengthen the application of the models. These efforts represent a challenging and exciting part of the IMF’s broader support of global efforts to improve financial surveillance and promote sound macroprudential frameworks.
JOSÉ VIÑALS
Financial Counsellor and Director
Monetary and Capital Markets Department
International Monetary Fund
Acknowledgments
I am grateful to the many contributing authors of this book. The papers that make up the many chapters of this volume are the result of collaboration among internal colleagues and external experts, and have benefited from comments from IMF staff, academics, market participants, and policymakers, as well as journal editors and referees.
This project would not have been possible without the backing of José Viñals. And my heartfelt thanks to my colleague, friend, and sometime co-author, Martin Čihák, for his support and sage advice throughout this venture.
The book has also benefited greatly since its inception from the professionalism and expertise of colleagues in the Communications Department, specifically, Sean Culhane, Patricia Loo, and Joanne Johnson.
Last but not least, I would like to thank Margarita Aguilar for her indispensable and patient assistance in the preparation of the manuscript; and James Morsink and Srobona Mitra for back-stopping me during the publication process.
Abbreviations
ABO | accrued benefit obligation |
ABS | asset-backed security |
AIB | Allied Irish Banks PLC |
AIG | American International Group |
AIRB | Advanced Internal Ratings Based |
Anglo IB | Anglo Irish Bank Corp. PLC |
ARCH | autoregressive conditional heteroskedasticity |
ASF | available stable funding |
BBVA | Banco Bilbao Vizcaya Argentaria |
BCBS | Basel Committee on Banking Supervision |
BCCH | Central Bank of Chile/Banco Central de Chile |
BCP | Basel Core Principles for Banking Supervision |
BHC | bank holding company |
BIS | Bank for International Settlements |
BoE | Bank of England |
BoI | Bank of Ireland |
BSI | Banking Stability Index |
BSM | banking stability measure |
BSMD | Banking System’s (portfolio) Multivariate Density |
BSoM | Black-Scholes-Merton |
BU | bottom-up |
CAPM | capital asset pricing model |
CAR | capital adequacy ratio (regulatory capital to risk-weighted assets) |
CCA | contingent claims analysis |
CCP | Copula Choice Problem |
CDO | collateralized debt obligation |
CDS | credit default swap |
CEBS | Committee of European Banking Supervisors |
CEDF | cumulative expected default frequency |
CESE | Central, Eastern, and Southern Europe |
C&I | commercial and industrial |
CIMDO | Consistent Information Multivariate Density Optimizing |
CN | capital need |
CNB | Croatian National Bank |
CoPoD | Conditional Probability of Default |
CPI | consumer price index |
CRE | commercial real estate |
CRI | credit risk indicator |
CRT | credit risk transfer |
CSFP | Credit Suisse Financial Products |
DAX | Deutscher Aktien IndeX |
DB | defined benefit |
DCC | dynamic conditional correlation |
DD | distance to default |
DiDe | Distress Dependence Matrix |
DNB | De Nederlandsche Bank |
DSI | debt service-to-income ratio |
DTA | deferred tax assets |
DtD | distance to distress |
EAD | exposure at default |
EC | economic capital |
ECB | European Central Bank |
EDF | expected default frequency |
EL | expected loss |
EMBI+ | Emerging Market Bond Index |
EMBIG | Emerging Market Bond Index Global |
ES | expected shortfall |
EU | European Union |
EVT | extreme value theory |
FFT | fast Fourier transform |
FIRB | Foundation Internal Ratings Based |
FME | Financial Supervisory Authority/Fjármálaeftirlitsins |
FMI | financial market infrastructure |
FSAP | Financial Sector Assessment Program |
FSB | Financial Stability Board |
FSC | Financial Services Center |
FSI | financial soundness indicator |
FSR | Financial Stability Report |
FVCDS | fair value CDS |
FVOAS | fair value option adjusted spread |
FX | foreign exchange |
GARCH | generalized autoregressive conditional heteroskedasticity |
GEV | generalized extreme value |
GFSR | Global Financial Stability Report |
GMM | Generalized Method of Moments |
GOB | Government of Brazil |
HBOS | Halifax Bank of Scotland |
HHI | Herfindahl-Hirschman Index |
HSBC | Hongkong and Shanghai Banking Corporation |
IBB | immediate borrower basis |
ICR | interest coverage ratio |
IFRS | International Financial Reporting Standards |
IFS | International Financial Statistics |
IMACEC | Indicador Mensual de Actividad Económica |
IPSA | Indice de Precios Selectivo de Acciones |
IRB | Internal Ratings Based |
IRF | impulse response function |
ISEQ | Irish Stock Exchange Overall Index |
IT | information technology |
JPoD | joint probability of distress |
KMV | Kealhofer, McQuown, and Vasicek (a part of Moody’s Analytics) |
LCR | liquidity coverage ratio |
LGD | loss given default |
LHS | left-hand side |
LIBOR | London Interbank Offered Rate |
LLR | loan loss reserve |
LS | least squares |
LTCM | Long Term Capital Management |
LTV | loan-to-value |
MCAR | market-implied capital adequacy ratio |
MES | marginal expected shortfall |
MfRisk | Macro-Financial Risk |
MGF | moment generating function |
MIDP | market implied default probabilities |
MKMV | Moody’s KMV |
ML | maximum likelihood |
MPS | macroprudential policy and surveillance |
MSCI | Morgan Stanley Capital International |
MSE | mean squared error |
MXED | minimum cross-entropy distribution |
NASDAQ | National Association of Securities Dealers Automated Quotations |
NBB | National Bank of Bankistan |
NBFI | nonbank financial institution |
NFI | net foreign investment |
NPL | nonperforming loan |
NSFR | net stable funding ratio |
OBS | off-balance-sheet |
OeNB | Austrian National Bank/Oesterreichische Nationalbank |
OIS | overnight indexed swap |
OLS | ordinary least squares |
OOM | out-of-the-money |
PAO | probability that at least one bank becomes distressed |
PBO | projected benefit obligation |
PBOcd | projected benefit obligation constant dollar |
PCA | principal component analysis |
PD | probability of default |
PGF | probability generating function |
PIT | Probability Integral Transformation |
PLD | profit and loss distribution |
PMD | portfolio multivariate distribution |
PoD | probability of distress |
QIRB | quasi-Internal Ratings Based |
QIS | Quantitative Impact Study |
RAMSI | Risk Assessment Model for Systemic Institutions |
RHS | right-hand side |
RBO | retirement benefit obligation |
RBS | Royal Bank of Scotland |
RNDP | risk-neutral default probability |
RNS | risk-neutral credit spread |
ROA | return on assets |
RRE | residential real estate |
RSF | required stable funding |
RWA | risk-weighted assets |
SAS | stand-alone subsidiarization |
SBIF | Banking Supervisory Agency/Superintendencia de Bancos e Instituciones Financieras |
SCAP | Supervisory Capital Assessment Program |
SELIC | Sistema Especial de Liquidação e Custodia |
SLOOS | Senior Loan Officer Opinion Survey of Bank Lending Practices |
SME | small-and medium-sized enterprise |
S&P | Standard and Poor’s |
SPD | state-price density |
SRL | Systemic Risk-Adjusted Liquidity |
SRM | Systemic Risk Monitor |
StA | Standardized Approach |
SWF | sovereign wealth fund |
TARP | Troubled Asset Relief Program |
TBTF | too-big-to-fail |
TCTF | too-connected-to-fail |
TD | top-down |
TMTF | too-many-to-fail |
TTC | through-the-cycle |
UL | unexpected loss |
URB | ultimate risk basis |
VaR | value at risk |
VAR | vector autoregression |
VDAX | implied volatility of the Deutscher Aktien IndeX (DAX) |
VIX | Chicago Board Options Exchange Market Volatility Index (implied volatility of the S&P 500 index) |
WaMu | Washington Mutual |
WEO | World Economic Outlook |
Contributing Authors
IMF Staff (past and present)
Renzo G. Avesani, Senior Economist, Monetary and Capital Markets Department. Currently Chief Risk Officer, Unipol Gruppo Finanziario (renzo.avesani@unipol.it).
Eugenio Cerutti, Senior Economist, Research Department (ecerutti@imf.org).
Jorge A. Chan-Lau, Senior Economist, Monetary and Capital Markets Department (jchanlau@imf.org). Currently Visiting Faculty, Robert H. Smith School of Business, University of Maryland and Senior Research Fellow, Risk Management Institute, National University of Singapore.
Martin Čihák, Advisor, Monetary and Capital Markets Department (mcihak@imf.org).
Elena Duggar, Economist, Monetary and Capital Markets Department. Currently Group Credit Officer, Moody’s Investors Service (elena.duggar@moodys.com).
Nombulelo Duma, Senior Economist, Monetary and Capital Markets Department (nduma@imf.org).
Marco A. Espinosa-Vega, Deputy Division Chief, Institute for Capacity Development (mespinosa@imf.org).
Michael T. Gapen, Economist, IMF Institute. Currently Managing Director, U.S. Economic Research, Barclays (michael.gapen@barclays.com).
Dale F. Gray, Senior Risk Expert, Monetary and Capital Markets Department (dgray@imf.org).
Maher Hasan, Deputy Division Chief, Monetary and Capital Markets Department. Currently Deputy Governor, Central Bank of Jordan (maher.hasan@cbj.gov.jo).
Heiko Hesse, Senior Economist, Strategy, Policy and Review Department (hhesse2@imf.org).
Anna Ilyina, Advisor, European Department (ailyina@imf.org).
Gregorio Impavido, Senior Economist, European Department (gimpavido@imf.org).
Andreas A. Jobst, Senior Economist, European Department (ajobst@imf.org).
Geoffrey N. Keim, Economist, Western Hemisphere Department (gkeim@imf.org).
Cheng Hoon Lim, Assistant Director, Monetary and Capital Markets Department (clim@imf.org).
Kexue Liu, Scientific Analyst, Technology and General Services Department. Currently Quant Programmer, Tradeweb Markets LLC (Kexue.Liu@tradeweb.com).
Andrea M. Maechler, Deputy Division Chief, Monetary and Capital Markets Department (amaechler@imf.org).
Rodolfo Maino, Senior Economist, African Department (rmaino@imf.org).
Yulia Makarova, Research Assistant, Monetary and Capital Markets Department. Currently Consultant, UNICEF (ymakarova@gmail.com).
Alin Mirestean, Section Chief, Technology and General Services Department (amirestean@imf.org).
Srobona Mitra, Senior Economist, Monetary and Capital Markets Department (smitra@imf.org).
Li Lian Ong, Deputy Division Chief, Monetary and Capital Markets Department. Currently Senior Vice President, Economics and Investment Strategy, GIC Private Limited (onglilian@gic.com.sg).
Marta Ruiz-Arranz, Deputy Division Chief, Fiscal Affairs Department (mruizarranz@imf.org).
Jean Salvati, Information Technology Officer, Technology and General Services Department. Currently Director of Product Management, Primatics Financial (jean.salvati@gmail.com).
Christian Schmieder, Economist, Monetary and Capital Markets Department. Currently Member of Secretariat, Basel Committee on Banking Supervision (Christian.Schmieder@bis.org).
Liliana Schumacher, Senior Economist, Monetary and Capital Markets Department (lschumacher@imf.org).
Miguel A. Segoviano, Deputy Division Chief, Monetary and Capital Markets Department (msegoviano@imf.org).
Juan Solé, Senior Economist, Western Hemisphere Department (jsole@imf.org).
Marcos Souto, Financial Sector Expert, Monetary and Capital Markets Department (msouto@imf.org).
Alexander F. Tieman, Senior Economist, European Department (atieman@imf.org).
Francisco Vazquez, Senior Economist, European Department (fvazquez@imf.org).
James P. Walsh, Deputy Division Chief, Monetary and Capital Markets Department (jwalsh@imf.org).
Torsten Wezel, Senior Economist, Monetary and Capital Markets Department (twezel@imf.org). Currently Principal Financial Sector Expert, European Central Bank (torsten.wezel@ecb.int).
Yingbin Xiao, Senior Economist, European Department (yxiao2@imf.org).
External Coauthors
Theodore Barnhill Jr., Professor of Finance, George Washington University (barnhill@gwu.edu).
Michel Canta, Deputy Superintendent of Private Pension Funds, Superintendence of Banking, Insurance, and Private Pension Funds of Peru (mcanta@sbs.gob.pe).
Charles A. E. Goodhart, Professor, Financial Markets Group, London School of Economics (c.a.goodhart@lse.ac.uk).
Manuel Luy, Head, Research Department, Superintendence of Banking, Insurance, and Private Pension Funds of Peru (mluy@sbs.gob.pe).
Benjamin Neudorfer, Analyst, Stress Tests and Strategy Unit, Supervision Policy, Regulation and Strategy Division, Oesterreichische Nationalbank (benjamin.neudorfer@oenb.at).
Pablo Padilla, Professor of Mathematics and Mechanics, Universidad Nacional Autonoma de México (Pablo@mym.iimas.unam.mx).
Claus Puhr, Head, Stress Tests and Strategy Unit, Supervision Policy, Regulation and Strategy Division, Oesterreichische Nationalbank (claus.puhr@oenb.at).
Stefan W. Schmitz, Head, Macroprudential Analysis Unit, Financial Stability and Macroprudential Supervision Division, Oesterreichische Nationalbank (stefan.schmitz@oenb.at).
Benjamin M. Tabak, Legislative Advisor, Federal Senate of Brazil (benjamim.tabak@gmail.com); Professor of Banking and Finance and Law and Economics, Catholic University of Brasilia; and CNPQ Foundation.
Disclaimer
The views expressed in this volume are those of the authors and do not necessarily represent those of their respective institutions.