Integrating Stress Tests within the Basel III Capital Framework: A Macroprudentially Coherent Approach

36 Pages Posted: 15 Feb 2017

Date Written: October 26, 2016

Abstract

In the post-crisis era banks’ capital adequacy is established by the Basel III capital standards and, in many jurisdictions, also by supervisory stress tests. In this paper we first describe the ways in which supervisory stress tests can supplement the risk-based capital framework of Basel III and how this could be codified with a stress test buffer. We then argue that in order to ensure coherence with the macroprudential objectives of Basel III, the severity of supervisory stress tests should be procyclical. In addition, to increase the transparency and predictability of the overall capital framework, severity choices should follow a constrained discretion approach based on a simple rule. Finally, we analyze supervisory stress testing practices across some jurisdictions and find that while the United States and the UK frameworks are in line with some of the elements of our proposal, including most notably the need for procyclical severity, this is not the case in the euro area.

Keywords: stress test, capital regulation, macroprudential policy

JEL Classification: G21, G28

Suggested Citation

Bologna, Pierluigi and Segura, Anatoli, Integrating Stress Tests within the Basel III Capital Framework: A Macroprudentially Coherent Approach (October 26, 2016). Bank of Italy Occasional Paper No. 360. Available at SSRN: https://ssrn.com/abstract=2917138 or http://dx.doi.org/10.2139/ssrn.2917138

Pierluigi Bologna (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

Anatoli Segura

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

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