Macroprudential stress testing
Macroprudential stress testing (MST) is central to systemic risk analysis. Unlike standard stress testing, it includes not only an assessment of financial institutions’ sensitivity to risk factors, but also a set of additional models to factor in intrasectoral and intersectoral linkages, market participants’ responses to shocks and their market interaction, as well as the secondary effects produced by the financial sector’s risks on the real economy, taking into account subsequent feedback effects.
As part of developing MST, in 2017, the Bank of Russia published its consultation paper Concept of Macroprudential Stress Testing and the article Macroprudential Stress Testing of the Financial Sector: International Experience and the Bank of Russia’s Approaches. In December 2020, the Bank of Russia released its analytical note Analysis of Systemic Risks in Macroprudential Stress Testing.
What is stress testing?
In a general sense, stress testing is the study of changes in the properties of a system or an object under non-standard (stress) conditions. In respect of a financial institution, stress testing is the evaluation of its financial resilience in a severe but plausible shock scenario.
Stress tests are conducted based on the scenario analysis using macromodelling approaches. The Bank of Russia also assesses sensitivity, including to the liquidity risk and the risk of credit concentration in certain industries.
The macroprudential part of stress testing supplements the supervisory stress testing of financial institutions, provides an understanding of macroeconomic consequences of stress, and helps develop appropriate response measures. MST is carried out top-down, using the available reporting of financial institutions and the findings of supervisory stress testing.
Features of MST
The objective of stress testing conducted by financial institutions or by a supervising authority is to assess the resilience of individual market participants to shocks, ensuring they have sufficient capital and liquid assets to maintain stability under stress conditions. This type of testing, however, overlooks the means of achieving stability and potential consequences of stress events at the macrolevel. Nevertheless, the resilience of individual stress testing participants does not always mean that the financial system as a whole will be able to preserve stability under stress conditions. This was starkly demonstrated during the
Use of MST results
MST is a vital tool for identifying systemic risks and implementing macroprudential policy. The analysis of systemic risks goes beyond the scope of the assessment of individual financial institutions’ risks and makes it possible to estimate systemic effects at the macroeconomic level. Stress testing results can be helpful in calibrating the countercyclical buffer for capital adequacy ratios and other macroprudential instruments of the Bank of Russia, including risk-weight add-ons and macroprudential limits.