Commercial Bank Stress Tests

In this short video on financial economics, we look at stress testing of commercial banks and building societies

Stress tests assess commercial banks’ ability to withstand severe shocks, but also to maintain the supply of credit under severe stress.

The Bank of England conducts annual stress tests to check the resilience of the banking system.

When a bank is found to have insufficient capital, then it must take steps to increase their capital reserves.

The 2019 Bank Stress Test for the UK

• Sterling exchange rate index falls by 28%
• Monetary policy base interest rates rise to 4%
• Household property prices fall by 33%
• Share prices fall 41%
• Start-to-trough fall in global GDP of -2.6%
• UK real GDP falls by 4.7%
• Unemployment rate rises to 9.2%

Commercial bank stress tests are simulations that are designed to assess the ability of a bank to withstand adverse economic conditions. The purpose of stress testing is to identify potential vulnerabilities in a bank's balance sheet and to assess the bank's ability to maintain sufficient capital levels in the event of a severe economic downturn.

The stress tests are typically conducted by regulators, such as the Federal Reserve in the United States or the European Banking Authority (EBA) in Europe, and are based on a set of scenarios that are designed to test the resilience of the bank's balance sheet under different economic conditions. These scenarios can include events such as a severe recession, a sharp increase in interest rates, or a large-scale financial crisis.

During the stress test, the bank's balance sheet is simulated under the different scenarios, and the bank's ability to maintain sufficient capital levels is evaluated. The results of the stress test are then used to identify potential vulnerabilities in the bank's balance sheet and to determine the steps that need to be taken to strengthen the bank's capital position.

The stress tests are conducted regularly, to ensure that the banks are able to withstand severe economic conditions and to maintain the stability and integrity of the financial system.

The stress test results are also used to set capital requirements for the banks, in order to ensure that they have enough capital to cover potential losses during a downturn. The stress test results are also made public, to increase transparency and to provide information to the market and the investors.