INTERNATIONAL BANKING

International Banking

Bank Stress Tests

Introduction

The instability, which the current global economy depicts, does not allow for any more years of such battering for the general public. The deteriorating international economy and collapses of related financial institutions, especially banks, have meant substantial losses for the citizens, making it very difficult for them to survive (Brunnermeier, 2009, pp.77).

The bank stress tests are instruments that allow banking regulators to test the financial strength of the banking institutions. These are progressive economic assessments that determine whether the banks in the economy have sufficient capital to withstand a possible period of economic recession and crisis (Mario, 2009, pp.56). As a result of this evaluation of the finances of a bank, the regulatory authorities identify whether a bank is well-capitalized or is low at reserves. In case a bank falls short of the requisite capital, it will be given a certain period to raise the necessary funds through private markets. Any bank failing to do so would either be bailed out by the respective government or treated according to the declared policies in this regard.

This paper aims at discussing these bank stress tests in detail, as well as, their importance and significance in present day situation. It also gives an account of the criticism that these tests have received in recent times, posing a question mark to their usefulness and future.

Discussion

Concept of Bank Stress Tests

The stress tests for assessing the financial strength of the banking institutions were first introduced as part of the Financial Stability report (FS) in the year 2004. The main purpose of conducting bank stress tests is to build confidence amongst the general public for the banking system. The bank stress tests intend to draw a sketch of the expected performance of a bank in case of some serious economic crunch or disaster. The risk that is associated with such an event is called as a “stress scenario” and can have great implications for a banking institution. Through stress testing, experts and authorities are able to establish whether the bank has gotten adequate capital reserves to cover up its losses in such a case (Mishkin, 2006, pp.88)

The bank stress tests provide an evaluation of the resilience of a bank in case the economy experiences some serious crisis. The credit risk is strongly coupled with the probable return of an investment, and the brand yielding is strongly correlated with their obvious credit risk. Because of credit risk; many businesses are closed, many employees losing their jobs, spending the money is progressively shrinking. Investors are remunerated for high credit risk by way of the borrower interest repayments.

The firm credit risk is defined as the prospect in failure to pay the losses to investors in case of default. The correlation of credit risk arises from the factors that affecting the firms credit risks. The common factor of risks that are impact on the firm risk management is interpreting correlation (Kane, 2009, pp.40). The credit risk is a big extent that is determined by common risk ...