Resilience of Indian banks: Macroeconomic stress test modeling for credit risk

Abstract

The macro stress testing is an integral part of the credit risk management exercise to judge the strength of banks in hypothetical stress situations. The present paper develops the macroeconomic stress testing model and checks the resilience of banks across different groups of banks in India like the public sector, private, and foreign banks in maintaining the minimum required regulatory capital at the time of stress situations. The stress testing exercise is undertaken by the use of panel data models to evaluate the impact of likely changes in macro parameters on the non‐performing loans under three stress scenarios like baseline, medium, and severe. The impact of these stress testing is substantial for the public sector banks as compared to private and foreign banks. Except for the few banks, all other public sector banks are not able to sustain the macro stress scenarios and became insolvent. In opposite to this, all the foreign banks are able to sustain all the stress scenarios. The private banks are also able to withstand the assumed crisis, except few banks failed to do so. The study may be useful for studying the preparedness of banks to face the crisis period and also helps them to get themselves equipped with the required capital to meet those circumstances.