Stress Testing Practices Research Articles

The Art of (Macroprudential) Stress Testing

After the recent global financial crisis, stress testing has emerged as one of the most prominent macroprudential tools. Despite its rising reputation and substantial development in the recent years, it still has some room for further improvements. In this paper, we review current stress testing practices and critically assess its benefits and shortcomings. In addition, we suggest some recommendations for stress testing practices in the future. Briefly, our analysis suggests that even though stress testing has developed substantially in terms of scenario construction and methodological aspects, it still has some weaknesses particularly from technicality and follow-up action appropriateness. We suggest that complementing stress testing result with additional monitoring information would be able to mitigate some of these drawbacks.

Stress Testing Banks: Whence and Whither?

This paper provides a brief overview of the recent practice of stress testing banking institutions, focusing on capital adequacy. We argue that stress testing has been successfully used to mitigate bank opacity; quantify systemic risk under extreme but plausible stress; keep the participants mindful of severely adverse shocks, thereby mitigating “disaster myopia” and concomitant financial instability; and improve the data collection and analytical capabilities of financial institutions. Our paper then reviews several critiques of stress testing made by policymakers and academics. We also propose several modifications of the current stress-testing practice, such as the fusion of liquidity and capital adequacy stress testing, expansion of granular data availability, and explicit modeling of sectors inextricably connected to banking as well as the feedback mechanisms from these sectors. Addressing these issues is likely to keep stress testing highly relevant for promoting financial stability in the future.

Stress Testing as a Tool for Assessing Systemic Risk of Organizations of the Russian Banking Sector

Under the conditions of competition improvement in banking sector, i.a. - on the part of international financial institutions, sophistication of operations and simultaneous access of banks to the instruments of risk hedging the task of building of risk-management system by banks with use of stress-testing becomes specially prioritized and relevant. The current instability on world financial markets being the consequence of global crisis stipulates the necessity for more searching examination and assessment of probable risks. The most important factor stipulating the stability of the commercial bank is being the application of adequate assessment of financial losses under the conditions of market’s instability. This will provide creation of prerequisites for effective control and management of risks in the period of increase of recessionary situation in the Russian economy. The goal of this paper is the conceptual research of stress-testing evolution as the method for assessment of systemic risks in the epoch of financial globalization, and also – the substantiation of recommendations on improvement of the system of practical realization of stress testing method in the framework of counter-cyclic regulation with account of tendencies for development of international banking supervision. The methodological background of research is based on the principles of comparative and system analysis, unity of qualitative and quantitative, historical and logical approach. In the paper the historical background is considered, novations in the area of legislative regulation of banking risks in Russia and abroad are analyzed. In the framework of research the main problems and disadvantages of existing practice of stress testing are defined, the approach of the Bank of Russia to conduction of stress-tests is characterized, the affairs, the implementation of which will help stress testing to take its proper place among the instruments for regulation and supervision of banking system of Russia. DOI: 10.5901/mjss.2015.v6n3s3p157

Ontology-based scenario modeling and analysis for bank stress testing

The 2008 banking crisis demonstrated that there is a lack of effective methods for modeling and analyzing “exceptional but plausible” risk scenarios in bank stress testing. Existing stress testing practices mainly focus on modeling probability-based risk factors and events in banking systems using historical data. Rare (low probability) risk events that can cause financial crises in banking systems, such as the bankruptcy of Lehman Brothers, are largely ignored due to the lack of appropriate modeling and analysis methods. To address this problem, we propose an approach called Banking Event-driven Scenario-oriented Stress Testing (or simply, BESST) which has two main components: 1) an ontology-based event-driven scenario model (OESM), and 2) two analysis methods based on OESM for scenario recommendation and plausibility checking. The proposed BESST approach provides bank stress testing stakeholders an effective method for modeling and analyzing financial crisis scenarios that are rare but often have significant consequences.

Pension Funds, the Requirement of Providing the Minimum Guaranteed Return and Excessive Legislative Restrictions of Pension Fund Investments

Abstract To reduce the exposure of the pension fund's members to financial risks, legislation in Slovenia and some other countries promises a so-called minimum guaranteed return and at the same time hinders the portfolio diversification process of pension funds. We intend to demonstrate in this article, on a case study basis and using a combination of empirical data from two Slovenian pension funds and a hypothetical one, that by precisely matching the investments' characteristics to the characteristics of the pension fund's liabilities, some important financial risks can be mitigated, while others can even be hedged entirely. We also intend to demonstrate that with the implementation of a proper policy of risk measurement and management, complemented with stress testing practices, excessive legislative restrictions for investments are no longer necessary. Some restrictions can even hinder portfolio diversification and the risk management process.

Macrofinancial Stress Testing: Principles and Practices-Background Material

Staff conducted a survey of stress testing practices among selected national central banks and supervisory authorities. The online survey was undertaken in November 2011 as part of the preparatory work for the paper on ― Macrofinancial Stress Testing: Principles and Practices. The survey focused on stress testing for banks, which is more widespread and better established — and practices are therefore easier to compare across countries — but also included questions on stress testing for nonbank financial institutions.

Macrofinancial Stress Testing - Principles and Practices—Background Material

Staff conducted a survey of stress testing practices among selected national central banks and supervisory authorities. The online survey was undertaken in November 2011 as part of the preparatory work for the paper on ?Macrofinancial Stress Testing: Principles and Practices. The survey focused on stress testing for banks, which is more widespread and better established—and practices are therefore easier to compare across countries—but also included questions on stress testing for nonbank financial institutions.

Macrofinancial Stress Testing - Principles and Practices

The recent financial crisis drew unprecedented attention to the stress testing of financial institutions. On one hand, stress tests were criticized for having missed many of the vulnerabilities that led to the crisis. On the other, after the onset of the crisis, they were given a new role as crisis management tools to guide bank recapitalization and help restore confidence. This spurred an intense debate on the models, underlying assumptions, and uses of stress tests. Current stress testing practices, however, are not based on a systematic and comprehensive set of principles but have emerged from trial-and-error and often reflect constraints in human, technical, and data capabilities.

Enhanced Stress Testing and Financial Stability

To date, regulatory stress testing in the United States has focused on ensuring the banking system is resilient to losses in one or a few stress scenarios that involve macro-economic weakness, but it is unclear how far this resilience extends beyond the stresses considered. In addition, a theory of which stress-scenarios should be chosen to achieve systemic-risk reduction objectives has not yet been developed. To improve stress testing practices, this paper proposes a framework for modeling systemic risk. The framework is used to analyze areas where current stress-testing practices can be improved. In addition, the paper proposes a new approach for systemic risk stress-testing and recapitalization policy that ensure the banking system is robust to a wide set of shocks, but minimizes the costs of achieving robustness through better sharing of risk.

Survey of Research on Financial Sector Modeling within DSGE Models: What Central Banks Can Learn from It

This survey gives insight into the ongoing research in financial frictions modeling. The recent financial turmoil has fueled interest in operationalizing financial frictions concepts and introducing them into tools for policy makers. The rapid growth of the literature on these issues is the motivation for our review of the presented approaches. The empirical facts that motivate the inclusion of financial frictions are surveyed. This survey provides a description of the basic approaches for introducing financial frictions into dynamic stochastic general equilibrium models. The significance and empirical identification of the financial accelerator effect is then discussed. The role of financial frictions models in CNB monetary and macroprudential policy is also described. It is concluded that given the heterogeneity of the approaches to financial frictions it is beneficial for the conduct of monetary policy to focus on the development of satellite approaches. The role of financial frictions in DSGE models for macroprudential policy is also discussed, as these models can be used to generate stress-testing scenarios. It can be concluded that DSGE models with financial frictions could complement current stress-testing practice, but are not able to replace stress tests.

A Systematic Approach to Multi-Period Stress Testing of Portfolio Credit Risk

We propose a new method for analysing multi-period stress scenarios for portfolio credit risk more systematically than in the current practice of macro stress testing. Our method quantifies the plausibility of scenarios by considering the distance of the stress scenario from an average scenario. For a given level of plausibility our method searches systematically for the most adverse scenario for the given portfolio. This method therefore gives a formal criterion for judging the plausibility of scenarios and it makes sure that no plausible scenario will be missed. We show how this method can be applied to a range of models already in use among stress testing practitioners. While worst case search requires numerical optimisation we show that for practically relevant cases we can work with reasonably good linear approximations to the portfolio loss function that make the method computationally very efficient and easy to implement. Applying our approach to data from the Spanish loan register and using a portfolio credit risk model we show that, compared to standard stress test procedures, our method identifies more harmful scenarios that are equally plausible.

Stress Testing Practice for Risk Management

Risk-management practices at financial institutions have undergone a quantitative revolution. Increasingly, financial firms rely on statistical models to measure and manage financial risks, ranging from market risks (such as exchange rate fluctuations) to credit risks (such as borrowers' default probabilities) to operational risks (such as expected losses due to fraudulent transactions). Such models have gained credibility because they provide a coherent framework for identifying, analyzing and communicating these risks. These are only simplifications of reality and cannot capture every aspect of these risks. For example, unlikely yet possible events that could cause significant losses are not captured readily by models constructed to monitor typical risk outcomes. To address this shortcoming, risk managers have developed a practice known as which also has become an important element of the supervisory monitoring of financial firms. Indeed, many supervisory agencies have begun using stress-testing techniques to assess the capital adequacy of individual firms and even national financial systems. We define stress testing, describe its possible applications, and highlight certain techniques developed to conduct this testing, and survey its recent use by supervisory agencies. The European Union plans to conduct its bank stress tests as an industry wide look at the health of the financial system. That way, it is expected that an overall view of the euro zone's banking system will be obtained. The European bank stress test results should be ready by September, in the hopes that the information will be helpful for junior finance ministers and central bank representatives at their autumn meeting.

Can Risk Modeling Work?

Does the 2007/08 market crisis herald the end of risk modeling and the empirical method? This paper supports the hypothesis that recent risk modeling problems were caused by the use of inappropriate risk models which are fixable rather than fundamentally flawed. An extensive analysis including the sub-prime crisis shows that GARCH-based risk measures offer a potential solution to these problems. The paper also explores some risk modeling issues that arose during the crisis such as the appropriate choice of sample size and how to incorporate dynamic feedback effects into a risk model used for stress testing. I illustrate a stress-testing method that applies the GARCH approach but results in relatively stable capital requirements preferred by practitioners. This method appears to address some of the concerns raised by regulators with respect to stress testing practices during the market turbulence and would result in more conservative gearing levels for financial institutions.

Variation in the use of stress testing and outcomes in patients with non-ST-elevation acute coronary syndromes: insights from GUSTO IIb

Non-invasive risk stratification of low- and intermediate-risk non-ST-elevation acute coronary syndromes (NSTE ACS) patients has been recommended, but limited data exist about the variation in clinical practice of stress testing in these patients and the impact of such testing on their outcomes. Patients with NSTE ACS enrolled in the GUSTO IIb (Global Use of Strategies To Open occluded coronary arteries in acute coronary syndromes-IIb) trial (n = 8011) were analysed to evaluate patterns of stress testing in US and non-US patients and to further evaluate the clinical characteristics, procedure use, and outcomes of patients who underwent stress testing compared with those who did not. Stress testing was performed in 1878 (24%) patients. Compared with patients not undergoing stress testing, those undergoing stress testing had low-risk characteristics and significantly lower death (0.6% vs. 4.8%), and death or myocardial infarction (MI, 3.9% vs. 11%) rates at 30 days. Stress testing was performed as often after as before coronary angiography. Importantly, stress testing was helpful in stratifying patients into low (equivocal or negative test) or high (positive test) risk groups (30 day death 3.1% vs. 5%). Stress testing was performed more often in non-US than US patients, and US patients were 3.5 times more likely to undergo imaging as part of stress testing. However, the risks of 30-day death or MI; 6-month death, MI or revascularization; and 1-year death did not differ between US and non-US patients. Stress testing is commonly performed in low-risk NSTE ACS patients and provides modest additional prognostic information in this cohort. Significant geographical variation exists in the use of stress testing. Therefore, in the current practice environment where cardiac catheterization is often the first diagnostic modality used in patients with NSTE ACS, the role of non-invasive testing both before and after invasive procedure is in need of further study.

Stress Testing Credit Risk: A Survey of Authorities' Approaches

This paper reviews the quantitative methods used at selected central banks to stress testing credit risk, focusing in particular on the methods used to link macroeconomic drivers of stress with bank specific measures of credit risk (macro stress test). Stress testing credit risk is an essential element of the Basel II Framework; because of their financial stability perspective, central banks and supervisors are particularly interested in quantifying the macro-to-micro linkages and have developed a specific modeling expertise in this field. In assessing current macro stress testing practices, the paper highlights the more recent developments and a number of methodological challenges that may be useful for supervisors in their review process of the banks' stress test models as required by the Basel II Framework. It also contributes to the on-going macroprudential research efforts that aim to integrate macroeconomic oversight and prudential supervision, in the direction of early identification of key vulnerabilities and assessment of macro-financial linkages.

Stress Testing At the IMF

For almost a decade, the IMF has been using stress tests to identify vulnerabilities across institutions that could undermine the stability of a country's financial system. This working paper focuses on the IMF's experience with stress testing in the Financial Sector Assessment Program (FSAP). It provides background on the nature of an FSAP and the role of macro stress testing within it. It also describes how the methodology of stress testing in FSAPs has been evolving and what are fairly common approaches now being used. Finally, it discusses the main strengths and challenges for future development of macro stress testing in FSAPs and provides an overview of stress testing practice in European FSAPs.

Introduction to Applied Stress Testing

Stress testing is a useful and increasingly popular, yet sometimes misunderstood, method of analyzing the resilience of financial systems to adverse events. This paper aims to help demystify stress tests, and illustrate their strengths and weaknesses. Using an Excel-based exercise with institution-by-institution data, readers are walked through stress testing for credit risk, interest rate and exchange rate risks, liquidity risk and contagion risk, and are guided in the design of stress testing scenarios. The paper also describes the links between stress testing and other analytical tools, such as financial soundness indicators and supervisory early warning systems. Furthermore, it includes surveys of stress testing practices in central banks and the IMF.

Introduction to Applied Stress Testing

Stress testing is a useful and increasingly popular, yet sometimes misunderstood, method of analyzing the resilience of financial systems to adverse events. This paper aims to help demystify stress tests, and illustrate their strengths and weaknesses. Using an Excel-based exercise with institution-by-institution data, readers are walked through stress testing for credit risk, interest rate and exchange rate risks, liquidity risk and contagion risk, and are guided in the design of stress testing scenarios. The paper also describes the links between stress testing and other analytical tools, such as financial soundness indicators and supervisory early warning systems. Furthermore, it includes surveys of stress testing practices in central banks and the IMF.

Current Practice of Exercise Stress Testing Among Pediatric Cardiology and Pulmonology Centers in the United States

The objective of this study was to characterize current practice patterns for clinical exercise stress testing (EST) in children in the United States. We conducted a survey of 109 pediatric cardiology programs and 91 pediatric pulmonology programs at children's hospitals or university hospitals in the United States. A total of 115 programs from 88 hospitals responded (response rate, 58%). A higher percentage of cardiology programs (98.7%) have exercise laboratories compared with pulmonology programs (77.5%). Sixty-three percent of respondents have both a treadmill and a cycle ergometer. A larger proportion of respondents (76%) rely primarily or exclusively on treadmill, whereas a smaller number use cycle ergometer (24%). Sixty-seven percent of respondents reported that they include metabolic measurements in EST protocols. Respondents have varying minimum age criteria for EST, with 9% reporting < or = 4 years, 25% reporting 5 years, 31% reporting 6 years, 16% reporting 7 years, and 20% reporting > or =8 years. Programs using cycle ergometers tend to test children at a younger age and to measure metabolic parameters. Seventy-nine percent of respondents use Bruce and modified Bruce protocols. Institutional protocols are used by 14%. Ninety percent of respondents use technicians to perform EST and 8% use nurses, but 76% require physician presence during testing. The majority of respondents (57%) perform < 100 pediatric tests per year. There are wide variations in the current practice of EST among pediatric subspecialty programs in the United States. Treadmills are used more frequently than cycle ergometers, and Bruce and modified Bruce protocols are commonly used. Most survey respondents measure metabolic parameters during EST.

Utility of immediate exercise treadmill testing in patients taking beta blockers or calcium channel blockers

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