Stress tests for banks have become well established worldwide, especially since the Great Financial Crisis, and by now many authorities regularly run stress tests that cover the banking sector. This paper reviews such exercises, drawing on the literature and a comparative analysis carried out by the Financial Stability Institute on system-wide stress tests for banks in the euro area, Japan, Switzerland and the United States. The paper identifies three building blocks in the setup of any stress test - governance, implementation and outcomes - and relates them to its policy objectives, which can be microprudential or macroprudential. On the basis of an extensive review of the choices that authorities need to make about the design of a stress test within each of these building blocks, it is argued that stress tests are most effective when their design is fully aligned with the policy objectives. This is because microprudential and macroprudential objectives may require different approaches. Consistency with the Basel Committee on Banking Supervision's high-level principles for stress testing is an important step in this regard.
JEL classification: E37, E44, G10, G21, G28
Read the full paper at: https://www.bis.org/fsi/publ/insights12.htm