The depth and duration of the financial crisis has led many banks and supervisory authorities
to question whether stress testing practices were sufficient prior to the crisis and whether
they were adequate to cope with rapidly changing circumstances. In particular, not only was
the crisis far more severe in many respects than was indicated by banks' stress testing
results, but it was possibly compounded by weaknesses in stress testing practices in reaction
to the unfolding events. Even as the crisis is not over yet there are already lessons for banks
and supervisors emerging from this episode.
Stress testing is an important risk management tool that is used by banks as part of their
internal risk management and, through the Basel II capital adequacy framework, is promoted
by supervisors. Stress testing alerts bank management to adverse unexpected outcomes
related to a variety of risks and provides an indication of how much capital might be needed
to absorb losses should large shocks occur. Moreover, stress testing is a tool that
supplements other risk management approaches and measures. It plays a particularly
important role in:
• providing forward-looking assessments of risk;
• overcoming limitations of models and historical data;
• supporting internal and external communication;
• feeding into capital and liquidity planning procedures;
• informing the setting of a banks’ risk tolerance; and
• facilitating the development of risk mitigation or contingency plans across a range of
stressed conditions.