Stress testing macro stress testing: does it live up to expectations?

Original by C.Borio, M. Drehmann & K. Tsatsaronis, BIS, 2017, 22 pages 

This summary note was Posted on

BIS Working papers No 369

  • What matters most is the mindset of the those employing it
  • Micro stress tests: test the performance of individual portfolios or the stability of individual institutions
  • Macro stress tests: test the stability of groups of financial institutions and which can have an impact on the economy as a whole
  • Objectives of macro stress tests: Identify vulnerabilities and support crisis management and resolution
  • Ong et al (2010) propose to use reverse stress tests as simple tools to uncover vulnerabilities in countries with limited data
  • Integrate credit and interest rate risk in the banking booking.  Need to model assests and liabilities simultaneously to take into account accounting consistency (Drehmann et al 2010)
  • Lack of econometrical equations means liquidity risk is modelled by a range of indicators that change in stressed conditions based on rules of thumbs calibrated to past prices (Kapadia et all 2011)
  • Most complete approach is RAMSI by the bank of England (Aikman et all 2009)
  • It has so far proved to be very hard to integrate market risk or liquidity risk with credit risk in the banking book
  • Two types of approaches: rely of history and use judgement to avoid the risk of relying excessively on the past (however judgement is often based on historical experience)