List of Bank Stress Tests Types and Scenarios

Bank stress tests are a crucial tool for regulators to assess a bank's resilience to economic shocks. They involve simulating various scenarios to gauge a bank's ability to withstand stress.

There are several types of bank stress tests, each with its own unique focus. For example, the Dodd-Frank Act Stress Test (DFAST) focuses on the impact of a severe recession on a bank's capital and liquidity.

The Comprehensive Capital Analysis and Review (CCAR) test, on the other hand, evaluates a bank's ability to maintain its dividend payments and capital distributions during a period of economic stress.

These tests help regulators to identify potential vulnerabilities in a bank's balance sheet and make informed decisions about capital requirements and other regulatory actions.

Bank stress tests are a simulation based on an examination of a bank's balance sheet. They were first used by large international banks in the early 1990s for internal self-assessment.

The Basel Capital Accord was amended in 1996 to require banks and investment firms to conduct stress tests to determine their ability to respond to market events. This was a significant step in making stress testing a standard practice.

In 2007, governmental regulatory bodies began conducting their own stress tests to ensure the effective operation of financial institutions. This was a major shift from relying solely on internal self-assessment.

Stress tests are now routinely performed by financial regulators in different countries or regions to ensure that banks under their authority are engaging in practices likely to avoid negative outcomes. In India, legislation was enacted in 2007 requiring banks to undergo regular stress tests.

The largest American banks are required to undergo stress tests twice per year, once internally and once conducted by regulators. This was introduced in 2012 as part of the Dodd-Frank Act.

Community banks can create various stress tests to evaluate credit portfolio risk and the potential impact on capital. These tests can be used to meet supervisory expectations or complement existing risk management activities.

Transactional Sensitivity Analysis is a type of stress test that involves analyzing financial and market assumptions to determine how a loan can withstand market fluctuations. This can help institutions determine whether to make a loan and formulate a more appropriate loan structure to mitigate credit risk.

Stressed Portfolio Loss Rates involve applying a set of portfolio loss rates that might be expected during downturn conditions to identify the extent to which capital might be at risk. For example, a bank could use portfolio loss rates from a previous economic recession and apply those to their current portfolio.

The first bank stress tests were relatively simple, focusing primarily on credit risk - the risk of borrowers defaulting on their loans. These tests typically involved applying a hypothetical adverse scenario to a bank's loan portfolio and calculating the potential losses.

Initially, these early tests had several limitations, including not considering other types of risk, such as market risk or operational risk. They also didn't take into account the potential for systemic risk - the risk that the failure of one bank could trigger a cascade of failures throughout the financial system.

Payment Systems Test is a crucial aspect of ensuring the stability and security of any financial system.

This type of test involves simulating real-world transactions to identify any potential issues or vulnerabilities.

Payment Systems Test can be conducted using various tools and techniques, including load testing and stress testing.

For example, a payment system's ability to handle a large volume of transactions in a short period of time can be tested using load testing.

The goal of Payment Systems Test is to ensure that the system can process transactions efficiently and accurately, even under heavy loads.

In a real-world scenario, a payment system might be tested by simulating a large number of users making transactions simultaneously.

Payment Systems Test can also involve testing the system's security features, such as encryption and authentication protocols.

This is essential to prevent unauthorized access to sensitive financial information.

Payment Systems Test is an ongoing process that requires regular maintenance and updates to ensure the system remains secure and efficient.

Debt-service coverage is a crucial risk measure for assessing the effect of financial factors on CRE loan repayment.

Institutions may find it beneficial to conduct stress tests using one or a combination of these risk factors. Many of these measures also apply to other loan categories.

Loan-to-value ratios and capitalization rates are essential risk measures that help evaluate the impact of economic factors on CRE loan repayment.

Property net operating income is another key risk measure that assesses the effect of market factors on CRE loan repayment.

Collateral value depreciation, including regional and local factors, is a significant risk measure that evaluates the impact of economic downturns on CRE loan repayment.

CRE sector performance, which includes office, retail, multi-family, warehouse/industrial, and lodging sectors, is a vital risk measure that assesses the effect of market factors on CRE loan repayment.

Interest-rate levels on variable-rate loans are a critical risk measure that evaluates the impact of economic factors on CRE loan repayment.

Contractual terms, such as amortization and balloon payments, can introduce refinancing or repayment risk, making them a key risk measure for CRE loan tests.

Occupancy status and lease rates are essential risk measures that help evaluate the impact of market factors on CRE loan repayment.

Unit absorption rates for real estate developments are a significant risk measure that assesses the effect of market factors on CRE loan repayment.

Economic factors, such as changes in local employment and house prices, are critical risk measures that evaluate the impact of economic downturns on CRE loan repayment.

Here are some common risk measures used in CRE loan tests:

Regulators use bank stress test results to inform their decisions, which can have a significant impact on the financial markets. If a bank performs poorly in a stress test, regulators may require it to raise additional capital or take other corrective actions.

Regulators may also use stress test results to determine whether a bank is allowed to increase its dividend payments or share buybacks. In the US, for example, regulators require the largest American banks to undergo stress tests twice per year.

Regulatory decisions based on stress test results can affect a bank's profitability and growth prospects, influencing its stock price and the prices of other financial instruments.

US regulators unveiled new rules in 2012 requiring the largest American banks to undergo stress tests twice per year.

These tests are conducted both internally by the banks and by the regulators themselves, with the first test being performed by the banks and the second by the regulators.

Starting in 2014, midsized firms with $10–50 billion in assets are also required to conduct Dodd-Frank Act Stress Testing.

The Federal Reserve has found that post-stress capital has increased since the initial Dodd-Frank Act Stress Testing began.

Bank stress tests are conducted by both individual banks and regulators to assess the resilience of banks under adverse conditions. Some tests are part of internal risk management processes, while others are required by regulators as part of their supervisory duties.

There are several types of bank stress tests, each with its own methodology and purpose. They can focus on specific types of risk or be more comprehensive in their approach.

Individual banks conduct internal risk management processes to identify potential vulnerabilities. These tests can help banks take proactive measures to strengthen their financial systems.

Regulators conduct stress tests to ensure banks are meeting their supervisory requirements. This helps to maintain stability in the financial system.

All bank stress tests share a common goal: to assess the resilience of banks under adverse conditions. By identifying potential vulnerabilities, these tests can help banks and regulators strengthen the financial system.

Regulatory decisions made by authorities can significantly impact a bank's financial stability and growth prospects. If a bank performs poorly in a stress test, regulators may require it to raise additional capital.

Regulators may also restrict a bank's dividend payments or share buybacks if it performs poorly in a stress test. This can affect the bank's profitability and growth prospects.

On the other hand, if a bank performs well in a stress test, regulators may allow it to increase its dividend payments or share buybacks. This can boost the bank's profitability and growth prospects.

A bank's performance in a stress test can also influence its stock price and the prices of other financial instruments. Regulators may take corrective actions if a bank performs poorly, which can have broader impacts on the financial markets.

Supervisory Guidance for Credit Exposures emphasizes the importance of stress testing for institutions with concentrations in commercial real estate lending and subprime lending.

Institutions with these concentrations should perform portfolio-level stress tests or sensitivity analyses to quantify the impact of changing economic conditions on asset quality, capital, and earnings.

The guidance recommends considering the sensitivity of portfolio segments with common risk characteristics to prospective changes in market conditions.

Stress testing should be consistent with the size, complexity, and risk characteristics of the portfolios and balance-sheet structure.

Institutions should focus on quantifying the impact of changing economic conditions on their asset quality, capital, and earnings.