Macroprudential Stress Testing of Credit Risk : A Practical Approach for Policy Makers

Drawing on the lessons from the global financial crisis and especially from its impact on the banking systems of Eastern Europe, the paper proposes a new practical approach to macroprudential stress testing. The proposed approach incorporates: (i)...

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Bibliographic Details
Main Authors:	Buncic, Daniel, Melecky, Martin
Format:	Policy Research Working Paper
Language:	English
Published:	2012
Subjects:	ACCOUNTING ASSET CLASS ASSET CLASSES BALANCE SHEET BANK BORROWERS BANK CREDIT BANK FOR INTERNATIONAL SETTLEMENTS BANK LENDING BANK PROFITS BANKING CRISES BANKING SECTOR BANKING SYSTEM BANKING SYSTEMS BANKS BENCHMARK BOND BUFFER BUFFERS BUSINESS CYCLE BUSINESS CYCLES CAPITAL ADEQUACY CAPITAL REQUIREMENT CAPITAL REQUIREMENTS CASH FLOW CENTRAL BANK CLASSIFIED LOANS COLLATERAL CONSENSUS FORECASTS CONSUMER LOANS CONSUMERS CONTROL VARIABLES CORRECTIVE ACTION CREDIT BOOM CREDIT BOOMS CREDIT CARD CREDIT CARDS CREDIT CONTRACTS CREDIT EXPOSURES CREDIT GROWTH CREDIT LINES CREDIT PROVISION CREDIT RISK CREDIT RISK EXPOSURES CREDIT RISKS CREDITS CURRENCY APPRECIATION CURRENCY CRISES CURRENCY CRISIS CURRENCY DEPRECIATION CURRENCY VALUE DEBT DEBT HOLDER DECISION MAKING DEFAULT SITUATIONS DEFAULTS DEPENDENT DEPENDENT VARIABLE DEPRECIATIONS DERIVATIVES DEVELOPING COUNTRIES DEVELOPMENT POLICY DIVIDENDS DOLLAR EXCHANGE RATE DOMESTIC CURRENCY DUMMY VARIABLES ECONOMETRIC MODEL ECONOMIC GROWTH ECONOMIC RISK EFFECT OF EXCHANGE RATE CHANGES ELASTICITY EMERGING ECONOMIES EMERGING MARKET EMERGING MARKET ECONOMIES EMPLOYMENT EQUILIBRIUM MODELS EXCHANGE RATE EXCHANGE RATE MOVEMENTS EXTERNAL COMPETITIVENESS FINANCIAL CRISES FINANCIAL CRISIS FINANCIAL DEEPENING FINANCIAL DISTRESS FINANCIAL REGULATION FINANCIAL SECTOR FINANCIAL STRESSES FINANCIAL SYSTEM FINANCIAL SYSTEMS FOREIGN BANKS FOREIGN CURRENCY FOREIGN CURRENCY DEBT FOREIGN CURRENCY EXPOSURES FOREIGN CURRENCY LENDING FUTURE FINANCIAL CRISES FUTURE RESEARCH FUTURE VALUE GDP PER CAPITA GENERAL EQUILIBRIUM GENERAL EQUILIBRIUM MODELS GROWTH RATES HOLDING INCOME INCOME EFFECT INCOME INEQUALITY INDIVIDUAL ASSET INDIVIDUAL BANK INDIVIDUAL BANKS INFLATION INFORMATION DISCLOSURE INSOLVENCY INSOLVENCY THRESHOLD INSTRUMENT INTEREST PARITY INTERNATIONAL BANK INTERNATIONAL BANKS JUDGMENT LENDING PRACTICES LETTERS OF CREDIT LIQUIDITY LIQUIDITY RISK LOAN LOAN COMMITMENTS LOAN CONCENTRATION LOAN LOSS LOAN LOSS PROVISIONS LOAN MATURITY LOANS TO CREDIT INSTITUTIONS LOCAL CURRENCY LONG-RUN EQUILIBRIUM MACROECONOMIC CONDITIONS MACROECONOMIC DATA MACROECONOMIC MODEL MACROECONOMIC MODELS MACROECONOMIC RISKS MACROECONOMIC SHOCKS MACROECONOMIC VARIABLE MACROECONOMIC VARIABLES MATURITY MISMATCHES MATURITY TRANSFORMATION MATURITY TRANSFORMATIONS MIDDLE INCOME COUNTRIES MONETARY FUND MORTGAGE MORTGAGE LOANS MULTIPLIERS NET EXPORTS NET LOSS NET LOSSES NOMINAL EXCHANGE RATE NON-PERFORMING LOANS NONPERFORMING LOANS NPL OPEN ECONOMY OUTPUT LOSS OVERDUE LOANS PARTICULAR ASSET PENALTY POLICY RESPONSE PORTFOLIO PORTFOLIOS POTENTIAL EXPOSURE PROBABILITY OF DEFAULT PROBLEM BANKS PUBLIC AGENCIES REAL GDP REAL INTEREST REAL INTEREST RATE REGIONAL BANKS REGRESSION ANALYSIS REPAYMENT REPAYMENT CAPACITY RESERVES RETURN RETURN ON ASSETS RISK FACTORS RISK PROFILES RISK WEIGHTED ASSETS SECURITIES SERIAL CORRELATION SHAREHOLDERS SIMULATION TECHNIQUES SOLVENCY SOLVENCY PROBLEMS STEADY STATE SUBSIDIARIES SYSTEMIC RISK TIER 1 CAPITAL TRANSITION ECONOMIES TROUGH UNCERTAINTY VARIANCE-COVARIANCE MATRIX WEIGHTS ZERO WEIGHT
Online Access:	http://www-wds.worldbank.org/external/default/main?menuPK=64187510&pagePK=64193027&piPK=64187937&theSitePK=523679&menuPK=64187510&searchMenuPK=64187283&siteName=WDS&entityID=000158349_20120105144231 http://hdl.handle.net/10986/3221

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Summary:	Drawing on the lessons from the global financial crisis and especially from its impact on the banking systems of Eastern Europe, the paper proposes a new practical approach to macroprudential stress testing. The proposed approach incorporates: (i) macroeconomic stress scenarios generated from both a country specific statistical model and historical cross-country crises experience; (ii) indirect credit risk due to foreign currency exposures of unhedged borrowers; (iii) varying underwriting practices across banks and their asset classes based on their relative aggressiveness of lending; (iv) higher correlations between the probability of default and the loss given default during stress periods; (v) a negative effect of lending concentration and residual loan maturity on unexpected losses; and (vi) the use of an economic risk weighted capital adequacy ratio as the relevant outcome indicator to measure the resilience of banks to materializing credit risk. The authors apply the proposed approach to a set of Eastern European banks and discuss the results.

Macroprudential Stress Testing of Credit Risk : A Practical Approach for Policy Makers

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