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The purpose of this study is to analyze the benchmark model and offer a practical implementation of the macro stress test. The emergence of complicated instruments such as securitized products has rendered the risk management methodologies used in non-crisis periods insufficient. The macro stress test has become prominent as both an internal risk management tool for financial institutions and a way for supervisory authorities to maintain financial stability. However, no practical model is available for transforming macro stress scenarios into the risk parameters of an institution’s internal model.

This study presents a model for assessing a company’s default risk through a multi-level regression based on simultaneous estimates of the impacts of company-specific, macroeconomic and sector-specific risk factors using panel and time series data.

Equity capital, EBITDA, the current ratio and the fixed assets to fixed liability ratio are selected as the company-specific factors, while the CPI core rate, overall unemployment rate, overnight call rate and JGB yield to subscribers are selected as the macroeconomic factors. The correlation coefficients among the latent sector factors are significant at 5 per cent. In addition, the accuracy ratio values prove that the presented model has more default prediction power than do models without them.

This study is the first to provide a benchmark model for incorporating macroeconomic variables into a credit risk model for use in a bottom-up macro stress test.

The Iranian banking industry has been greatly affected by dramatic changes in macroeconomic conditions over the past several decades owing to volatile oil revenues, changing fiscal and monetary policies, and the imposition of US sanctions. The main objective of this paper is to estimate potential credit losses in the Iranian banking sector due to macroeconomic shocks and assess the minimum economic capital requirements under the baseline and distressed scenarios. The paper also contrasts the applications of linear and nonlinear models in estimating the impacts of macroeconomic shocks on financial institutions.

The paper uses a multistage approach to derive the portfolio loss distribution for banks. In the first step, the dynamic relationship between the selected macroeconomic variables are estimated using a VAR model to generate the stress scenarios. In the second step, the default probabilities are estimated using a quantile regression model and the results are compared with those of the conventional linear models. Finally, the default probabilities are simulated for a one-year time horizon using Monte-Carlo method and the portfolio loss distribution is calculated for hypothetical portfolios. The expected loss includes the loss given default for loans drawn randomly and uniformly distributed and exposed at default values when loans are assigned a fixed value.

The results indicate that the loss distributions under all scenarios are skewed to the right, with the linear model results being very similar to those of quantile at the 50% quantile, but very unlike those at the 10% and 90% quantiles. Specifically, the quantile model for the 90% (10%) quantile generates estimates of minimum economic capital requirement that are considerably higher (lower) than those using the linear model.

The study has focused on credit risk because of lack of data on other types of risk at individual bank level. The future studies can estimate the aggregate economic capital using a risk aggregation approach and a panel data (not presently available), which could further improve the accuracy of the estimates.

The fiscal and monetary authorities in developing countries, specially oil-exporting countries, can follow the risk assessment approach to assess the health of their banking system and adapt policies to mitigate the impacts of large macroeconomic shocks on their financial markets.

This is the first paper estimating the portfolio loss distribution for the Iranian banks under turbulent macroeconomic conditions using linear and nonlinear models. The case study can be applied to other developing and emerging countries, particularly those highly dependent on natural resources, prone to extreme macroeconomic shocks.

The purpose of this paper is to discuss issues relating to stress testing methods for credit risks in banks. Also, it suggests a solution to bank supervisors on evaluating stress test results.

Discussion is based on cases analysis on a stress period of the Hong Kong banking sector.

The paper finds that econometric modeling does not work well modeling stress scenarios. The stressed probability of default (PD) provided by Basel II would be much higher than stressed PD observed in the history.

Bank supervisors should develop cost‐effective methods to monitor the stress test results reported by banks.

The paper addresses the issues of stress testing and provides a practical solution for bank supervisors to monitor stress test results reported by banks.

This paper aims to provide a methodology for designing and conducting solvency stress tests, under the standardised approach as per IFSB-15, including the establishment of macro-financial links, running scenarios with variation of assumptions and stress scenario parameters; apply and illustrate this methodology by providing a stylised numerical example through a tractable Excel-based framework, through which Islamic Commercial Banks (ICBs) can introduce additional regulatory requirements and show that they would remain in compliance with all capital requirements after a moderate to severe shock; and identify the potential remedial actions that can be envisaged by an ICB.

The paper uses the data of the one of the groups to which certain amendments and related assumptions are applied to develop a stylised numerical example for solvency stress-testing purposes. The example uses a Stress Testing Matrix (STeM; a step-by-step approach) to illustrate the stress-testing process. The methodology of the paper uses a two-stage process. The first stage consists of calculating the capital adequacy ratio (CAR) of the ICB using the IFSB formulae, depending on how the profit sharing investment account (PSIA) are treated in the respective jurisdiction. The second stage is the application of the stress scenarios and shocks.

Taking into account the specificities of ICBs such as their use of PSIA, the results highlighted the sensitivity of the CAR of an ICB with respect to the changes in the values of alpha and the proportion of unrestricted PSIA on the funding side. The simulation also indicated that an ICB operating above the minimum CAR could be vulnerable to shocks of various degrees of gravity, thus bringing the CAR below the minimum regulatory requirement and necessitating appropriate remedial actions.

The paper highlights various implications and relationships arising out of stress testing for ICBs, including the vulnerability of an ICB under defined scenarios, demanding appropriate immediate remedial actions on future capital resources and capital needs. The findings of the paper provide a preliminary discussion on developing a comprehensive toolkit for the ICBs similar to what is developed by the International Monetary Fund Financial Sector Assessment Programme.

This paper focuses on the gap with respect to the stress testing of capital adequacy. The main contribution of the paper is twofold. The first is the development of an STeM – a step-by-step approach, which provides a method for simulating solvency (i.e. capital adequacy) stress tests for ICBs; the second is the demonstration of the potentially crucial impact of profit-sharing investment accounts and the way they are managed by ICBs (notably the smoothing of profit payouts) in assessing the capital adequacy of the ICBs.

This paper aims to examine whether the Indian banking system is robust to withstand unexpected shocks from external and domestic macroeconomic factors after financial liberalization in 1992. As proposed by Demirgüç-Kunt and Detragiache (1998) and Kaminsky and Reinhart (1999) banking crisis follows financial liberalization. India embarked financial deregulation from 1992, whereas the ongoing global financial crisis (GFC) could jeopardize bank portfolios.

Stress test is undertaken through the vector auto regressive (VAR) model to examine if decline in GDP, exchange rate volatility and foreign capital portfolio funds adversely impact bank asset quality through higher defaults. The VAR model is run for banks belonging to public, private or foreign ownership. Soundness of banks is measured by the non-performing assets (NPAs) with quarterly data from 1997 to 2014. Post-VAR estimation technique, Granger causality test (GC) and impulse response function (IRF) are used to check for robustness of the VAR model findings.

The authors found that there is little divergence among banks of different ownership in responding to the shocks from REER, foreign capital flows and GDP output gap. IRF shows that GDP shock to NPA of public and private banks takes more than nine and eight quarters to stabilize. Foreign banks are impacted by the same macroeconomic factors. The stress test exhibits that public banks are more vulnerable and need recapitalization. Moreover, domestic banks are not adversely affected by the GFC, and credit for this could be attributed to the Reserve Bank of India’s (RBI’s) regulatory policy.

Surprisingly, capital market indices do not influence banks’ NPA, and this needs further investigation. The limitation arises from the fact that stock market index for banks was launched only in the early 2000. Missing data and limited number of banks shares traded in the market could explain the trivial results.

Findings of this study will be useful to RBI policymakers and bank managers. The exchange-rate risk faced by borrowers that lead to increased NPAs is an issue that the RBI would be interested to examine. The impact of foreign capital flows, adversely influencing the NPAs of banks, is a significant issue that the RBI is concerned with.

Banking sector crisis has serious repercussions, causing loss of household savings and decline in confidence in the banking sector.

This topic was explored in India only by Bhattacharya and Roy in (2008). No other similar work has been done to the authors’ knowledge in stress test of banks in India across different ownership. The authors’ study period covers the GFC and shows that it has not caused devastation as it has in developed countries.

The increased capital requirements and the implementation of new liquidity standards under Basel III sparked various concerns among researchers, academics and other stakeholders. The question is whether Basel III regulation is ideal, that is, adequate to deal with a crisis, such as the 2007–2009 global financial crisis? The purpose of this paper is threefold: First, perform a stress testing exercise on the US banking sector, while examining liquidity and solvency risk indicators jointly under the Basel III regulatory framework. Second, allow the study to cover the post-crisis period, while referring to key Basel III regulatory requirements. And third, focus on the resilience of domestic systemically important banks (D-SIBs), which are supposed to support the US financial system in times of stress and therefore whose failure causes the entire financial system to fail.

The authors used a sample of the 24 largest US banks observed over the period Q1-2015 to Q1-2021 and a scenario-based vector autoregressive conditional forecasting approach.

The authors found that the model successfully produces accurate forecasts and simulates the responses of the solvency and liquidity indicators to different real and historical macroeconomic shocks. The authors also found that the US banking sector is resilient and can withstand both historical and hypothetical macroeconomic shocks because of its compliance with the Basel III capital and liquidity regulations, which consist of encouraging banks to hold high-quality liquid assets and stable funding resources and to strengthen their capital, which absorbs the losses incurred in a crisis.

The authors developed a framework for testing the resilience of the US banking sector under macroeconomic shocks, while examining liquidity and solvency risk indicators jointly under Basel III regulatory framework, a point not yet well studied elsewhere, and most studies on this subject are based on precrisis data. The authors also focused on the resilience of D-SIBs, whose failure causes the failure of the entire financial system, which previous studies have failed to examine.

This paper aims to understand Japan’s financial regulatory responses after the global financial crisis and recession. Japan’s post-crisis reactions show two seemingly opposing trends: collaboration with international organizations to strengthen the regulation to maintain financial stability, and regulatory forbearance for the banks with troubled small and medium enterprise [SME] borrowers. The paper evaluates the responses by the Japanese financial regulators in five areas (Basel III, stress tests, over-the-counter [OTC] derivatives regulation, recovery and resolution planning and banking policy for SME lending) and concludes that the effectiveness of the new regulations for financial stability critically depends on the willingness of the regulators to use the new tools.

This report evaluates the post-crisis responses by the Japanese financial authorities in five dimensions (Basel III, stress tests, OTC derivatives regulations, recovery and resolution planning and bank supervision).

The effectiveness of the new regulations for financial stability critically depends on the willingness of the regulators to use the new tools.

The paper is the first attempt to evaluate the financial regulatory trends in Japan after the global financial crisis.

The paper is to understand how the financial system is influenced by macroeconomic shocks and how the financial stance, in turn, feeds back into the macroeconomic environment is key for policy makers. The most recent financial crisis has demonstrated the need for a deeper understanding of these interdependencies. The purpose of this paper is to analyze what macroeconomic shocks affect the soundness of the German banking system.

The paper draws on a micro‐macro stress‐testing framework for the German banking system in which macroeconomic and bank‐specific data are used to identify the effects of various shocks in a structural vector autoregressive model, which includes main macroeconomic variables and an indicator of stress in the banking system. To this end, the sign‐restriction approach is applied.

First, it is found that there is a close link between macroeconomic developments and the stance of the banking sector. Second, monetary policy shocks are the most influential shocks for distress in the banking sector. Third, fiscal policy shocks and real estate price shocks have a significant impact on the distress indicator, while evidence is mixed for the exchange rate. Fourth, for the identification of most shocks it is essential to work in the integrated model that combines the micro‐ and the macro‐sphere.

The paper analyzes various shock scenarios in an integrated micro‐macro framework that takes the mutual relationship between the financial stance and the macroeconomic environment into account.