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Stress Testing the Banking System: Methodologies and Applications


Mario Quagliariello


European Banking Authority; Bank of Italy

January 12, 2009

STRESS TESTING THE BANKING SYSTEM, M. Quagliariello, ed., Cambridge University Press, Forthcoming

Abstract:     
Stress tests are quantitative tools used by banking supervisors and central banks for assessing the soundness of the financial system in the event of extreme, but still plausible, shocks (macroeconomic stress tests). They are also an important management instrument for banks since they provide financial institutions with useful indications on the reliability of the internal systems designed for the measurement of risks (microeconomic or prudential stress tests). Under the new Basel Accord on banks' capital adequacy the presence of sound stress testing methodologies is a prerequisite for the adoption of the advanced methods for the quantification of minimum capital requirements.

Until the first half of 2007, the interest for stress testing had been circumscribed to practitioners, i.e., risk managers, central bankers and financial supervisors. Since then, the global financial system has been hit by deep turbulence's and all major economies have been affected by high volatility in financial markets, deterioration of the value of portfolios, widespread repricing of risk and severe liquidity drying up. It has been pointed out that the severity of the crisis has been largely due to its unexpected nature and that a more extensive and rigorous use of stress testing methodologies would have probably contributed to alleviate the intensity and the repercussions of the turmoil. In such a context, stress tests have become a key issue in policy discussions and a regular subject for newspapers' columnists.

Notwithstanding the importance of the topic, books covering the different facets of macroeconomic stress testing are missing so far. While many articles have been published on specific issues and some textbooks deal with prudential stress tests, a systematic survey of methodologies and applications of macroeconomic stress testing is not available.

This book aims at filling this gap, by providing practitioners and academics with a comprehensive and updated discussion of the theoretical underpinnings as well as the practical aspects of the implementation of such exercises. Prudential stress tests carried out by banks are not analysed in the book, even though it is not always practicable (and sensible) to distinguish them from macroeconomic stress tests.

The book builds on the experience gained by the economists of many national and international financial authorities in their day-to-day surveillance activity. All the contributors have an extensive expertise in financial stability issues and stress testing methodologies. Obviously, due to space constraints some potential interesting applications may have been omitted. Nevertheless, the book - while not exhaustive - is wide-ranging and includes outstanding presentations of the most significant approaches as well as an inner description of the state-of-the-art in this field.

While tailored for an expert readership, the book has the ambition to remain accessible to other readers, thanks to its plain language, clear explanation of the different issues, recurrent use of examples. The reader can either pick specific chapters of interest or easily move from simple to more complex topics as she progresses through the text.

Number of Pages in PDF File: 67

Keywords: stress tests, financial stability, financial crises, banks, credit risk, market risk, liquidity risk, risk aggregation

JEL Classification: G18, G21, G28, G38, C00

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Date posted: January 10, 2009 ; Last revised: May 1, 2009

Suggested Citation

Quagliariello, Mario, Stress Testing the Banking System: Methodologies and Applications (January 12, 2009). STRESS TESTING THE BANKING SYSTEM, M. Quagliariello, ed., Cambridge University Press, Forthcoming. Available at SSRN: http://ssrn.com/abstract=1325756

Contact Information

Mario Quagliariello (Contact Author)
European Banking Authority ( email )
Tower 42
25 Old Broad Street
London, EC2N 1HQ
Great Britain
Bank of Italy ( email )
Via Milano, 53
00184 Rome
Italy
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