Stress Testing, Capital Planning, and Risk Integration
The term “stress test” describes a range of techniques used to assess the vulnerability of a portfolio to major changes in the economic environment or to exceptional but plausible events. In order to use the IRB approach for computing the credit capital requirement, Basel II requires banks to carry out a stress test analysis. Basel II also requires stress testing for Pillar II purposes within the ICAAP. In addition, stress testing clearly becomes very useful from a managerial point of view because it helps identify risk sources and define strategies to handle negative events. Stress testing induces banks to focus on their key risk exposures and induces them to improve model calibration in order to take into account the types of worst cases as described, among others, by the Committee of European Banking Supervisor (2010) and the European Banking Authority (2011).
KeywordsCredit Risk Economic Capital Default Probability European Banking Authority Unexpected Loss
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