Stress Testing Banks: Whence and Whither?

30 Pages Posted: 5 Jan 2016

See all articles by Pavel S. Kapinos

Pavel S. Kapinos

Federal Reserve Bank of Dallas--Financial Industry Studies

Oscar A. Mitnik

Inter-American Development Bank; IZA Institute of Labor Economics

Christopher Martin

Federal Deposit Insurance Corporation (FDIC)

Multiple version iconThere are 2 versions of this paper

Date Written: November 1, 2015

Abstract

This paper provides a brief overview of the recent practice of stress testing banking institutions, focusing on capital adequacy. We argue that stress testing has been successfully used to mitigate bank opacity; quantify systemic risk under extreme but plausible stress; keep the participants mindful of severely adverse shocks, thereby mitigating “disaster myopia” and concomitant financial instability; and improve the data collection and analytical capabilities of financial institutions. Our paper then reviews several critiques of stress testing made by policymakers and academics. We also propose several modifications of the current stress-testing practice, such as the fusion of liquidity and capital adequacy stress testing, expansion of granular data availability, and explicit modeling of sectors inextricably connected to banking as well as the feedback mechanisms from these sectors. Addressing these issues is likely to keep stress testing highly relevant for promoting financial stability in the future.

Keywords: Stress testing, banks, Dodd-Frank Act, systemic risk, liquidity, disaster myopia, financial instability

JEL Classification: G21, G28

Suggested Citation

Kapinos, Pavel S. and Mitnik, Oscar A. and Martin, Christopher, Stress Testing Banks: Whence and Whither? (November 1, 2015). FDIC Center for Financial Research Paper No. 2015-07, Available at SSRN: https://ssrn.com/abstract=2710846 or http://dx.doi.org/10.2139/ssrn.2710846

Pavel S. Kapinos (Contact Author)

Federal Reserve Bank of Dallas--Financial Industry Studies ( email )

2200 North Pearl Street
PO Box 655906
Dallas, TX 75265-5906
United States

HOME PAGE: http://https://sites.google.com/site/pavelkapinos/

Oscar A. Mitnik

Inter-American Development Bank ( email )

1300 New York Ave, NW
Washington, DC 20577
United States

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Christopher Martin

Federal Deposit Insurance Corporation (FDIC) ( email )

550 17th Street NW
Washington, DC 20429
United States

HOME PAGE: http://sites.google.com/site/chrismartin122/

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