The risks of over simplifying stress test models

Original by American Banker, 2013 

This summary note was Posted on

Appeared also in May 2013, Moody’s analytics under the title Simple Models and the CCAR

  • Over reliance on too few macroeconomic drivers
  • The way the supervisory Stress Scenarios are defined suggests that very simple models involving only two or three economic drivers will fail to adequately represent the effect of each scenario
  • Many banks only use two variables: House prices and unemployment
  • Inflation has an important impact on many aspects of credit performance
  • Adverse stagflation is a very interesting test for bank risk managers to apply, holding potential of insights regarding performance of bank portfolios and management actions that may be available to mitigate the situation.