Stress Tests of UK Banks Using a VAR Approach

43 Pages Posted: 29 Dec 2005

See all articles by Glenn Hoggarth

Glenn Hoggarth

Bank of England

Steffen Sorensen

Moody's Investor Services

Lea Zicchino

Prometeia SpA; Dipartimento di Analisi e Ricerca Economica, Prometeia

Date Written: November 2005

Abstract

This paper adopts a new approach to stress testing the UK banking system. We attempt to account for the dynamics between banks' write-offs and key macroeconomic variables, through conditioning our stress test on the historical correlation between the variables and allowing for feedback effects from credit risk to the macroeconomy. In contrast to most existing empirical stress testing work, this paper uses a direct measure of banks' fragility - the write-off to loan ratio. We find that both UK banks' total and corporate write-offs are significantly related to deviations of output from potential. Following an adverse output shock, total and corporate write-off ratios increase. Mortgage arrears, on the other hand, appear to be mainly dependent on household income gearing. The results suggest that, even if the most extreme economic stress conditions witnessed over the past two decades were repeated, the UK banking sector should remain robust.

Keywords: Macro stress testing, bank fragility, loan write-offs, VAR analysis

JEL Classification: E44, G21

Suggested Citation

Hoggarth, Glenn and Sorensen, Steffen and Zicchino, Lea, Stress Tests of UK Banks Using a VAR Approach (November 2005). Bank of England Working Paper Series No. 282. Available at SSRN: https://ssrn.com/abstract=872693 or http://dx.doi.org/10.2139/ssrn.872693

Glenn Hoggarth (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Steffen Sorensen

Moody's Investor Services

New York, NY 10007
United States

Lea Zicchino

Prometeia SpA ( email )

Viale G. Marconi 43
Bologna
Italy

HOME PAGE: http://www.prometeia.it

Dipartimento di Analisi e Ricerca Economica, Prometeia ( email )

Viale G. Marconi 43
Bologna
Italy

HOME PAGE: http://www.prometeia.it

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