Stress-testing banks’ corporate credit portfolio

The paper describes the methods used by the French Banking Supervision Authority (ACP) to run stress tests for the corporate credit portfolio, through credit migration matrices (or transition matrices). This approach is currently used for “top-down” stress tests exercises. Developed for Basel II, it is still relevant under the Basel III framework. It includes sufficient flexibility to accommodate the severe crisis period observed recently. The paper introduces the basic model underlying the approach, largely based on Merton’s model; it then describes carefully the different steps for its practical implementation, providing hints on how it can be extended to other banking sectors. Finally the paper comments a few outputs of a stress testing exercise.