The adoption of stress testing: Why the Basel capital measures were not enough

The Basel capital adequacy ratios lost credibility with financial markets during the financial crisis. This article argues that the failure was because of the reliance of the Basel standards on overstated asset values in reported equity capital. The US stress tests were able to assist in restoring credibility, in part because they could capture deterioration in asset values. However, whether stress tests will prove equally valuable in the next crisis is not clear. Only some of the weaknesses in the Basel ratios are being addressed. Moreover, the US tests’ success was because of a combination of circumstances that may not exist next time.