Drawing on the lessons from the global financial crisis and especially from its impact on the banking systems of Eastern Europe, the paper proposes a new practical approach to macroprudential stress testing. The proposed approach incorporates: (i) macroeconomic stress scenarios generated from both a country specific statistical model and historical cross-country crises experience; (ii) indirect credit risk due to foreign currency exposures of unhedged borrowers; (iii) varying underwriting practices across banks and their asset classes based on their relative aggressiveness of lending; (iv) higher correlations between the probability of default and the loss given default during stress periods; (v) a negative effect of lending concentration and residual loan maturity on unexpected losses; and (vi) the use of an economic risk weighted capital adequacy ratio as the relevant outcome indicator to measure the resilience of banks to materializing credit risk. The authors apply the proposed approach to a set of Eastern European banks and discuss the results.
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Author
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Document Date
2012/01/01
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Document Type
Policy Research Working Paper
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Report Number
WPS5936
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Volume No
1
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Total Volume(s)
1
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Country
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Region
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Disclosure Date
2012/01/01
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Disclosure Status
Disclosed
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Doc Name
Macroprudential stress testing of credit risk : a practical approach for policy makers
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Keywords
financial and private sector development;macroeconomic variable;asset class;care needs;stress testing;individual bank;probability of default;loans to credit institution;macroeconomic condition;banking system;real gdp;idiosyncratic risk factor;outcome indicator;Capital Adequacy Ratio;loan loss reserve;foreign currency lending;emerging market economy;list of countries;cost of credit;real interest rate;loan loss provision;dynamic panel data;nominal exchange rate;exchange rate movement;business cycle literature;dollar exchange rate;foreign currency exposure;standard normal distribution;optimal lag length;international policy makers;tier 1 capital;credit risk exposure;global financial crisis;lending rate;statistical model;empirical application;loss distribution;macroeconomic model;credit growth;individual asset;risk weight;
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Citation
Buncic,Daniel Melecky,Martin
Macroprudential stress testing of credit risk : a practical approach for policy makers (English). Policy Research working paper ; no. WPS 5936 Washington, D.C. : World Bank Group. http://documents.worldbank.org/curated/en/994091468251373046/Macroprudential-stress-testing-of-credit-risk-a-practical-approach-for-policy-makers