A Framework for Stress Testing Banks’ Corporate Credit Portfolio

Olivier de Bandt, Nicolas Dumontaux, Vincent Martin and Denys Médée

Since the financial crisis of 2007 and beyond, which drew unprecedented attention to the stress testing of financial institutions, stress-tests exercises have become a central risk-management tool to assess the potential impact of extreme events on banks’ 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 weaknesses of both a single financial institution and threats to financial stability. Nowadays, financial institutions are required to perform regular exercises within Pillar II of the regulatory framework of the Basel Accord in order to assess the global impact of adverse events or changes in market conditions on banks’ capital adequacy. Supervisory authorities as well are used to leading such exercises: the International Monetary Fund (IMF) with its regular Financial Sector Assessment Program, the European Banking Authority (EBA) with its European “bottom-up” stress tests, including a disclosure step, and national supervisory authorities, which all have built dedicated tools, especially for regular top-down exercises. The scope of stress