The Bank stress test refers to the measurement of the losses that banks will experience in possible adverse scenarios. The analysis under hypothetical scenarios is designed to determine whether a bank has enough capital to withstand a negative economic shock. An example of these negative scenarios is a deep recession or a financial market crash.

The Importance of Bank Stress Tests

Bank stress tests have been implemented globally since the 2008 Crisis. After the crisis, regulators worldwide realized that large and well-established banks in any country were critical to that country’s economy. Understanding the importance of banks resulted in a desire to protect them from possible bad scenarios.

Another importance of stress testing is banks’ contribution to risk management. Bank stress tests add another layer of regulation that forces financial institutions to improve their risk management frameworks and internal business policies. It forces banks to think about adverse economic environments before making critical decisions.