November 27, 2018

FSI published a paper that presents the findings of a comparative analysis on the system-wide stress tests for banks in the euro area, Japan, Switzerland, and the United States. The paper identifies three building blocks in the setup of any stress test—governance, implementation, and outcomes—and relates them to the policy objectives, which can be micro-prudential or macro-prudential.

On the basis of an extensive review of the choices that authorities need to make about the design of a stress test within each of these building blocks, the paper argues that stress tests are most effective when their design is fully aligned with the policy objectives associated with them. This is because micro-prudential and macro-prudential objectives may require different approaches. Consistency with the Basel Committee's high-level principles for stress testing is an important step in this regard. Stress tests are best used in combination with other tools available to the authorities to achieve their policy objectives, such as systemic risk monitoring or capital planning reviews.

The analysis suggests that stress testing is being continually improved and further developments could help to enhance the implementation and the policy use of stress tests. There are several areas in which stress tests could be improved, such as, on the implementation side, the joint treatment of solvency and liquidity risks, or the specification of second-round, spillover and contagion effects. On the policy side, more authorities could use stress tests as an input to the calibration of macro-prudential measures. Additionally, stress tests could be further integrated into regular supervisory reviews.

Some of these changes will be driven by progress in research or advances in technology, while others will be dependent on gaining enough practical experience, especially in the macro-prudential sphere. From a global perspective, a dialog among relevant authorities regarding a common scenario design for large and cross-border active banks would be a helpful addition to the stress testing landscape.

 

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Keywords: International, Banking, Stress Testing, Systemic Risk, Macro-prudential Policy, FSI

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