A comparative analysis of different stress testing frameworks for assessing risks in the banking sector

Abstract

The global financial crisis is considered by many to have been amongst the worst crisis in history which has brought about a number of financial reforms in the financial system. As a result, many policymakers, researchers and practitioners showed an increased interest in better understanding the factors which led to such crisis, which are the vulnerabilities of financial systems. Indeed, there was increased interest with respect to stress testing practices, as these are techniques which are used to quantify, assess and forecast the position of different financial institutions under extreme but plausible events, if certain risks had to materialize within the financial system. This study involves a compare and contrast analysis of different stress testing models employed by different central banks and other financial institutions in order to gauge different type of risks such as capital adequacy and insolvency risk, credit risk, liquidity risk and market risk. In conclusion, the resulting analysis of this study highlights that the majority of stress testing frameworks follow a top-down approach, however, with distinct modelling strategies.