A New Framework for Stress Testing Banks’ Corporate Credit Portfolio

Olivier de Bandt, Vincent Martin and Eric Vansteenberghe

Since the global financial crisis triggered a major overhaul of the banking regulatory framework, unprecedented attention has been given to the stress testing of financial institutions. As a consequence, stress-test exercises have become a key risk management tool to assess the potential impact of extreme events on banks’ profit and loss (P&L) and balance-sheet structures. Stress tests are viewed as complementary to traditional risk measurement metrics such as value-at-risk (VaR) as they are an important mechanism for detecting the weaknesses of a single financial institution as well as threats to financial stability.

Globally, financial institutions are now required to perform regular exercises within Pillar II of the regulatory framework of the Basel Accord to assess the overall impact of adverse events or changes in market conditions on banks’ capital adequacy. Supervisory authorities are used to leading such exercises. For instance, the International Monetary Fund (IMF) has its regular Financial Sector Assessment Program, the European Banking Authority (EBA) has the Single Supervision Mechanism in Europe with their “bottom-up” stress tests that are disclosed on an