Bank for International Settlements, 2005, “Stress Testing at Major Financial Institutions: Survey Results and Practice,” Committee on the Global Financial System (Basel, January).
Blaschke, Winfrid, Matthew T. Jones, Giovanni Majnoni and Soledad Martinez Peria, 1988, “Stress Testing of Financial Systems: An Overview of Issues, Methodologies and FSAP Experiences,” IMF Working Paper No. 01/88 (Washington, International Monetary Fund).
Bunn, Philip, Alastair Cunningham and Mathias Drehmann, 2005 “Stress Testing as a Tool for Assessing Systemic Risks,” Financial Stability Review, June 2005 (London: Bank of England).
Cihak, Martin, 2004, “Designing Stress Tests for the Czech Banking System,” CNB Internal Research and Policy Note No. 3/2004 (Prague: Czech National Bank).
Cihak, Martin and Jaroslav Hermanek, 2005, “Stress Testing the Czech Banking System: Where are We? Where are We Going?” CNB Internal Research and Policy Note No. 2/2005 (Prague: Czech National Bank).
Eklund, Trond, Kai Larsen and Eivind Bernhardsen, 2001, “Model for Analyzing Credit Risk in the Enterprise Sector,” Economic Bulletin 3/2001 (Oslo: Norges Bank).
Goodhart, Charles and Lea Zicchino, 2005, “A Model to Analyze Financial Fragility,” Financial Stability Review, June 2005 (London: Bank of England).
Jones, Matthew T., Paul Hilbers and Graham Slack, 2004, “Stress Testing Financial Systems: What to Do When the Governor Calls,” IMF Working Paper No. 04/127 (Washington: International Monetary Fund).
Prepared by Li Lian Ong, with input from Martin Cihak (both MFD) and the Banking Supervision Department of the Bulgarian National Bank.
In 2004, the Committee on the Global Financial System (CGFS) initiated an exercise on stress tests undertaken by banks and securities firms. The objectives of the exercise were to determine the main risk scenarios for financial institutions, and to explore how stress testing practices have evolved over time (BIS, 2005).
Cihak and Hermanek (2006) provide a cross-country comparison of stress tests presented by central banks in their recent financial stability reports (FSRs). They review 36 recent FSRs, focusing on the features of the respective stress tests (see Table A.1). Virtually all the stress tests presented in the respective FSRs are based on bank-by-bank data. Countries in the survey include Australia, Austria, Belgium, Brazil, Canada, Chile, Denmark, Euro Area, Estonia, Finland, France, Germany, Hungary, Hong Kong, Indonesia, Iceland, Indonesia, Ireland, Italy, Israel, Latvia, Luxembourg, Netherlands, New Zealand, Norway, Philippines, Poland, Portugal, Slovak Republic, Slovenia, Spain, Sweden, Switzerland and the United Kingdom.
Blaschke, Jones, Majnoni and Martinez Peria (1988) discuss the stress-testing analyses conducted for FSAPs.
That said, not many banks actually do their own stress-testing, and even then, the models are not sophisticated. Some banks also apply value-at-risk (VaR) models, which are also available to on-site supervisors.
According to the BNB, it would strongly discourage the use of IRB models, with the advent of Basel II, since most banks in the system are unlikely to have sufficient historical data to credibly implement these models just yet.
CAEL refers to: Capital adequacy, Asset quality, Earnings and Liquidity.
CAMEL refers to: Capital adequacy, Asset quality, Management, Earnings and Liquidity.
It should be noted that any deterioration in loan quality leads to a change in RWA. RWA are affected when testing for changes in credit risk; RWA remains unchanged when interest rate and exchange rate risks are tested.
For example, loans to budget (mostly loans to municipalities, amounting to 0.2 percent of total loans), commercial real estate and construction loans, other commercial loans, agricultural loans, consumer loans, residential mortgage loans to individuals, among others.
The stress-testing model agreed between the BNB and the 2002 FSAP mission incorporated a 50 basis points change in the leva interest rate only.
Derivatives instruments include foreign exchange, interest rate, equity, commodity and other derivatives contracts. Shocks are applied to the positive (marked-to-market) values of these instruments.
This is one of the measures introduced by the BNB to restrain credit growth.
The recapitalization amount for Scenario 1 appears to be somewhat similar to the credit shock of a 10 percent migration of standard loans to loss.
The Bank of England’s stress-test model has changed significantly since the 2002 FSAP (see Bunn, Cunningham and Drehmann, 2005; Goodhart and Zicchino, 2005). The new model is built from micro foundations, with core (theoretical) and non-core (set of equations which fit data better and pick up correlations) components, whereas the old model was more data driven. Norges Bank (2004) indicates that the central bank plans to develop its existing SEBRA model (see Eklund, Larsen and Bernhardsen, 2001), which predicts bankruptcy probabilities based on annual accounts figures for all Norwegian limited companies, by incorporating some market indicators.
According to the BNB, it currently excludes explicit testing of liquidity risk in the banking sector, given that liquidity in the system is very high. According to BNB estimates, the banking system would be able to cover up to around 30 percent of deposits at present, in the event of a bank run.
According to the BNB, its stress tests take this potential scenario into account by excluding overseas funding from the calculation of relevant ratios.