What is a stress test in banking
A stress test in the land of finance is an analysis or simulation designed to determine the ability a financial instrument has to deal with an economic crisis. Usually projections are based on the best case scenarios. We’ve all seen Dragons Den for example, where the pitcher is asked about yearly projections, Yr1,2,3. These estimates are based on hitting targets, growing workforce & consistent economy etc. In the lucrative world of banking the following is usually considered in a stress test;
– What happens if unemployment rises to x%?
-What happens if equity markets crash by more than x% this year?
-What happens if GDP falls by x% in a year?
-What happens if interest rates rise by x%?
-What happens if oil prices rise by x%?
Stress testing models allow not only the individual stressors to be tested, but also test for a combination of different events occurring. In 2014, 25 banks failed the stress test conducted by the EBA. The bank stress test is a simulation on an examination of the current balance sheet of that particular institution. Seeing if a bank has enough capital to withstand the adverse impacts is also a prerogative of the stress test. Stress tests were first introduced in the early 1990’s and were carried out internally by the banks themselves. Government bodies and financial regulators began to carry out routine stress tests. Bank stress tests attracted a lot of attention in 2009 as the worst financial crisis since the Great Depression left many banks and financial institutions extremely under-capitalised. Recent stress tests were carried out in August 2016 and it was concluded that the European banking system is fragile. Italian banks in particular are at record lows. Major banks such as Commerzbank, Credit Suisse and Deutsche bank have seen huge declines. Credit Suisse and Deutsche bank have actually been dropped from the exclusive Stoxx 50 index following the recent stress test which could be an indication of things to come.