Reinforcing Market Confidence with Consistent Stress Testing

Financial institutions have been criticized for failing to fully identify and manage the risks that they have been exposed to, resulting in significant losses for some time. For instance, as mentioned on, the top 10 banks had $379 billion in asset write-downs and credit losses since the beginning of 2007. Thus, markets have lost their confidence with them, whereas governments are still bailing them out. On the other hand, banks have also lost their confidence against the markets; as a result they primarily give access to expensive and limited credit and liquidity. Ironically, depositors find it unsafe and also unprofitable to deposit banks.

Nowadays, financial institutions are struggling to comply with the tsunami of new regulations facing them and the direction given by regulators and central banks is more of fire-fighting than proactive in nature. As the markets are very dynamic and interact globally, there is a need to constantly upgrade and align rules among them. A natural downstream of this is the accumulation of rules banks need to comply with, which results in an enormous amount of global and local regulation all over the world.

Both financial institutions and markets are skeptical about whether new regulations are capable of increasing the confidence among each other or instead whether they will just increase the complexity of the financial system. Paradoxically, even after so many regulations, central banks and regulators are still not fully convinced about the risk management capabilities, transparency and consistency of the models and reports provided by the financial institutions.

Indeed, all players in the financial system are under stress. In this paper we will explore how financial institutions are able to systematically increase the confidence from both their customers and regulators by applying integrated and consistent stress testing techniques and methodologies.