From Stress to Costress: Stress Testing Interconnected Banking Systems

Abstract

This paper presents an integrated framework for assessing systemic risk. The framework models banks’ capital asset ratios as a function of future losses and credit growth using a generalized method of moments to calibrate shocks to credit quality and credit growth. The analysis is complemented by a simple measure of systemic risk, which captures tail risk comovement among banks in the system. The main contribution of this paper is to advance a simple framework to integrate systemic risk scenarios that assess the impact of aggregate and idiosyncratic factors. The analysis is based on CreditRisk , which uses analytical techniques - similar to those applied in the insurance industry - to estimate banks’ credit portfolio loss distributions, making no assumptions about the cause of default.

Keywords: Banking systems, Credit expansion, Credit risk, Economic models, External shocks, Risk management