Cervantes, Ricardo, Phakawa Jeasakul, Joseph Maloney and Li Lian Ong, 2014, Ms. Muffet, the Spider(gram) and the Web of Macro-Financial Linkages, IMF Working Paper, WP/14/99.
Prepared by Frederic Lambert.
A 25 percent provisioning rate on new NPLs is assumed. The effect of the shock on risk-weighted assets is assumed to be of the same magnitude as the effect on capital.
The test considers the cumulative gap at a 12-month horizon. It assumes the increase in interest rate is passed through symmetrically to deposit and lending rates.
This means that 6 percent of FX loans currently performing would become non-performing following the assumed 30 percent depreciation shock. The provisioning rate on new NPLs is set at 25 percent.
This effect is mechanic given the maturity gap between assets and liabilities and the assumed symmetric pass-through to deposit and lending rates in the model. In reality, banks expect a positive effect on their income from a rise in interest rates as the pass-through to deposit rates is projected to be much smaller than the increase in lending rates.
The combined shock scenario combines all the shocks that were previously examined separately. While somehow extreme, it may represent a more realistic crisis scenario, in which a large exchange rate depreciation accompanied by an increase in global interest rates would force an increase in domestic interest rates that would negatively affect economic activity and trigger an increase in domestic credit risk.
The exercise assumes a loss given default of 100 percent following a credit shock and that 35 percent of the funding lost as a result of a bank failure is not replaceable, with a funding-shortfall induced loss factor of 1.