Stress-testing the banking system : methodologies and by Mario Quagliariello

By Mario Quagliariello

"Stress checks are utilized in possibility administration via banks to be able to be certain how sure main issue eventualities may have an effect on the price in their portfolios, and by means of public professionals for monetary balance reasons. till the 1st half 2007, curiosity in stress-testing used to be mostly limited to practitioners. due to the fact then, the worldwide economic system has been hit through deep turbulences, together with the fallout from sub-prime Read more...

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2002). 15 A framework for assessing financial stability Banks and financial firms participate in the markets to meet their funding needs and to manage the risks coming from the structure of their balance sheets; markets are also participated in by non-financial firms and government bodies. The household sector is also an indirect user of some markets, particularly those that offer longer term saving opportunities. Financial markets may face difficulties in different ways: (1) a disruption of the infrastructures may render markets no more able to perform their core functions; (2) a loss of confidence may limit the involvement of intermediaries and impact on the formation of prices; and (3) a failure of a key market player or a sudden change in the risk attitude of market participants can have even wider effects and reduce market liquidity conditions.

While historical scenarios are easier to implement and somewhat more tangible, hypothetical scenarios may be the only available option when structural breaks in the financial system – such as deregulation, consolidation, the change of the currency, etc. 11 In fact, the calibration of a shock corresponding to an event that could occur once every 100 years is reasonable only if the external environment is expected to be stable over the same time horizon (Oyama, 2007). Nevertheless, the use of historical episodes often helps define the magnitude of hypothetical shocks.

The author is indebted to Patrizia Baudino, Francesco Cannata, Luciana Mancinelli and Marina Moretti for valuable comments on a draft version. 1 Financial soundness indicators are indicators of the current financial health and soundness of the financial institutions in a country, and of their corporate and household counterparts. They embrace both aggregated individual institution data and indicators that are representative of the markets in which the financial institutions operate (IMF, 2006). 2 Objectives of stress-testing: the micro and macro perspectives Stress-testing techniques have been applied at the individual level by large, internationally active banks since the early 1990s.

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