Stress Testing During Times of War

Abstract

The COVID crisis raises important questions about the role of stress testing during periods of systemic distress. Should stress testing of banks be abandoned? Modified? Proceed as scheduled? Different jurisdictions have taken different tacks, reflecting contestation over these fundamental issues. This essay argues that stress tests become more important, not less, in the midst of systemic distress, but only if the stress scenarios are modified to reflect the distinct challenges an economy is facing. Well-designed stress tests can provide critical information to policy makers and others, promoting more timely efforts to address underlying weaknesses. Given that regulators will rationally be hesitant to produce, much less disclose, information that could exacerbate the very crisis regulators are seeking to contain, crisis-time stress testing is only viable if regulators also have the tools needed to address any bad news the testing may reveal.

Keywords: financial crisis, COVID-19, stress testing, bank supervision, Federal Reserve

JEL Classification: E32, E44, E58, E63, G28