Next Generation Balance Sheet Stress Testing

Abstract

This paper presents a "second-generation" solvency stress testing framework extending appliedstress testing work centered on Čihák (2007). The framework seeks enriching stress tests interms of risk-sensitivity, while keeping them flexible, transparent, and user-friendly. The maincontributions include (a) increasing the risk-sensitivity of stress testing by capturing changes inrisk-weighted assets (RWAs) under stress, including for non-internal ratings based (IRB) banks(through a quasi-IRB approach); (b) providing stress testers with a comprehensive platform touse satellite models, and to define various assumptions and scenarios; (c) allowing stress testersto run multi-year scenarios (up to five years) for hundreds of banks, depending on the availabilityof data. The framework uses balance sheet data and is Excel-based with detailed guidance anddocumentation.