The usefulness of stress testing exercise for assessing the soundness of the banking system

Stress testing is becoming the principal diagnostic tool for bank risk management and capital adequacy requirements throughout the world. Supervisors are conducting stress test exercises in order to access the financial robustness of individual banks as well as possible vulnerabilities in the banking system as a whole. The paper offers an overview of stress testing methodology and usefulness, and then focuses on the comparison between the stress testing exercise conducted by CEBS (now EBA) in 2010 and that conducted by the US Federal Reserve in 2009 (SCAP). Stress testing modeling is the latest chapter in the revolution of financial decisions quantification and the first part of the paper focuses on some relevant aspects of micro and macro stress testing methodologies. Then, building on the theoretical framework presented, a comparative study is conducted. Despite the objections raised, both exercises received wide publicity beyond the community of financial experts and contributed to the risk awareness of the banks participated in the exercises.