Stress Testing and Scenario Analysis: The Customization Challenge

Recent bank defaults have proved that “one size fits all” regulatory stress tests do not work. Are there practical ways of individualizing prescribed scenarios and correlations between risk drivers without creating overwhelming complexity?

What’s the best approach for assessing a bank’s capital and liquidity adequacy? Moreover, what tools can we use to more accurately forecast tail risk, and do traditional stress tests still have value? These are among the key questions being asked in the wake of sudden and historic bank runs.

There are no simple answers, but there’s one thing we know: a bank is a complex institution with a level of vulnerability commensurate with its specific assets and liabilities. Indeed, each has its own business model and risk profile, with an individual level of exposure to different asset classes.

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