Stress Testing Stress Tests: Challenging the Authority of Indicators

Abstract

This paper examines macroprudential stress tests carried out by financial supervisors from a legal perspective. Stress tests are highly contingent because of their use of a number of controversial indicators such as adverse scenarios and risk models. At the same time, they constitute highly effective exercises of public authority. From a public law perspective, this raises their question whether the current legal framework is suitable. In light of the potential of supervisory stress tests to cause externalities and to second-guess financial regulation, the paper argues that supervisory stress tests should be regulated on the international level. The paper makes specific proposals for international legal rules relating to the design and conduct of stress tests as well as their use and follow-up measures.