IMF published a working paper on stress testing interconnected banking systems

01 February 2012

The paper, entitled 'From Stress to CoStress: Stress Testing Interconnected Banking Systems', presents an integrated framework for assessing systemic risk.

The framework models banks’ capital asset ratios as a function of future losses and credit growth, using a generalised method of moments to calibrate shocks to credit quality and credit growth. The analysis is complemented by a simple measure of systemic risk, which captures tail risk co-movement among banks in the system.

The main contribution of this paper is to advance a simple framework to integrate systemic risk scenarios that assess the impact of aggregate and idiosyncratic factors. The analysis is based on CreditRisk+, which uses analytical techniques - similar to those applied in the insurance industry - to estimate banks’ credit portfolio loss distributions, making no assumptions about the cause of default.

An integrated framework for systemic risk analysis needs to consider risks from both the macro-economic environment and banks’ interconnectedness. This paper uses a general setup to present a simple framework to assess the resilience of a banking system to aggregate and idiosyncratic shocks, advancing a toolbox that can be used in financial sector risk assessments. In this framework:

 

• banks’ CARs are modelled in a format that considers the simultaneous impact of future credit losses, credit growth, and the credit spread;
• the analysis focuses on economic measures of solvency and uses a generalised method of moments to calibrate the shocks to NPLs and credit growth;
• uncertainty about banks’ future losses is modelled in CreditRisk+, which relies on analytical techniques to find the banks’ credit portfolio loss distributions;
• a simple systemic risk indicator is proposed to measure tail risk comovements among the banks in the system; and
• quantile regressions and CreditRisk+  are used to model banks’ conditional VaRs.

Full paper

© International Monetary Fund