Open AccessA Globally Consistent Stress Testing Approach
Author(s) -
Colin Ellis
Publication year - 2019
Publication title -
research in economics and management
Language(s) - English
Resource type - Journals
eISSN - 2470-4407
pISSN - 2470-4393
DOI - 10.22158/rem.v4n3p153
Subject(s) - solvency , basel ii , stress test , contrast (vision) , capital requirement , basel iii , order (exchange) , default , econometrics , loan , expected shortfall , operational risk , stress testing (software) , economics , actuarial science , capital (architecture) , computer science , monetary economics , risk management , finance , microeconomics , market liquidity , programming language , archaeology , artificial intelligence , history , incentive
This paper describes an approach for stress testing banks that is consistent across economies and geographies, in contrast to common “macro scenario” driven approaches. The latter would require economic scenarios to be both equally likely (in a probabilistic sense) and equally stressful (in a conditional loss sense) across countries in order to be comparable. The paper proposes a three-pronged approach for stressing bank solvency, which incorporates recalibrating pre-crisis Basel capital assumptions, adapting the BIS “expected shortfall” approach for securities, and using granular data for income haircuts. Loan losses are quantified using a simple “multiples” approach, starting from expected outcomes, which is derived from the pre-crisis Basel technical proposal. The approach is practical, can be more granular or conducted at a high level, depending on data availability, and offers a simple way for regulators, investors or risk assessors to compare and contrast stresses in different banking systems. Of the eight bank defaults recorded globally during 2017, this approach would have given a better “rank ordering” for seven of them, indicating the approach adds value to traditional solvency metrics.