Stress tests and their contribution to financial stability

Abstract

One of the main responsibilities of the relevant supervisory authority is to ensure a sound, stable and efficient financial system. An essential part of the stability and efficiency of a financial system depends on those same facets of the banking system, which are based on prudential regulation and effective supervision. The progressive implementation of stress tests as a tool complementing traditional supervisory practices is making them increasingly valuable to financial authorities in monitoring and safeguarding the stability of the financial environment. The increasing use of stress tests highlights the need to establish basic principles and guidelines providing for a systematic approach to them that is rigorous and straightforward. This paper is intended to offer those guidelines. In essence, it reviews the most representative features of stress exercises. It also explains stress test methodology, basically how to set up and carry out an exercise appropriate for the structure, complexity and risk profile of the system under examination. A general conclusion is drawn on the significance this tool will, for various reasons, have in the near future. [PUBLICATION ABSTRACT]