Table Of Content

A Guide to IMF Stress Testing Methods and Models Editor Li Lian Ong I N T E R N A T I O N A L M O N E T A R Y F U N D ©International Monetary Fund. Not for Redistribution ©2014 International Monetary Fund Cover design: IMF Multimedia Ser vices Division Cata loging- in- Publication Data Joint Bank- Fund Library A guide to IMF stress testing : methods and models / editor, Li Lian Ong. — Washington, D.C. : International Monetary Fund, 2014. p. ; cm. Includes bibliographical references and index. 1. Financial crises. 2. Banks and banking, International. 3. International Monetary Fund. I. Ong, Li Lian. II. International Monetary Fund. HB3725.G84 2014 ISBN: 978- 1- 48436- 858- 9 (paper) ISBN: 978- 1- 47555- 129- 7 (web PDF) Disclaimer: Th e views expressed in this book are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management. Please send orders to: International Monetary Fund, Publication Ser vices P.O. Box 92780, Washington, DC 20090, U.S.A. Tel.: (202) 623- 7430 Fax: (202) 623- 7201 E-mail: [email protected] Internet: www .elibrary .imf .org www.imfbookstore.org ©International Monetary Fund. Not for Redistribution For Mark W. Swinburne June 17, 1955– September 3, 2009 Assistant Director Monetary and Capital Markets Department International Monetary Fund Manager, mentor, friend ©International Monetary Fund. Not for Redistribution This page intentionally left blank ©International Monetary Fund. Not for Redistribution Contents Foreword ......................................................................................................................................................................................ix JOSÉ VIÑALS Ac know ledg ments ....................................................................................................................................................................xi Abbreviations ...........................................................................................................................................................................xiii Contributing Authors ............................................................................................................................................................xvii 1. Stress Testing at the International Monetary Fund: Methods and Models ............................1 LI LIAN ONG • MARTIN ČIHÁK PART I THE ACCOUNTING BASED APPROACH A. THE BALANCE SHEET BASED APPROACH 2. Introduction to the Balance Sheet– Based Approach to Stress Testing .................................13 CHRISTIAN SCHMIEDER • LILIANA SCHUMACHER 3. Stress Tester: A Toolkit for Bank- by- Bank Analysis with Accounting Data ............................17 MARTIN ČIHÁK 4. Into the Great Unknown: Stress Testing with Weak Data ............................................................45 LI LIAN ONG • RODOLFO MAINO • NOMBULELO DUMA 5. Next-G eneration Applied Solvency Stress Testing ........................................................................59 CHRISTIAN SCHMIEDER • CLAUS PUHR • MAHER HASAN 6. Of Runes and Sagas: Perspectives on Liquidity Stress Testing Using an Iceland Example ......................................................................................................................71 LI LIAN ONG • MARTIN ČIHÁK 7. Next-G eneration Systemwide Liquidity Stress Testing ................................................................91 CHRISTIAN SCHMIEDER • HEIKO HESSE • BENJAMIN NEUDORFER • CLAUS PUHR • STEFAN W. SCHMITZ 8. Systemic Bank Risk in Brazil: A Comprehensive Simulation of Correlated Market, Credit, Sovereign, and Interbank Risks .....................................................103 THEODORE BARNHILL JR. • MARCOS SOUTO 9. Modeling Correlated Systemic Bank Liquidity Risks ..................................................................123 THEODORE BARNHILL JR. • LILIANA SCHUMACHER 10. Review and Implementation of Credit Risk Models ..................................................................135 RENZO G. AVESANI • KEXUE LIU • ALIN MIRESTEAN • JEAN SALVATI ©International Monetary Fund. Not for Redistribution vi Contents 11. Bankers without Borders? Implications of Ring- Fencing for Eu ro pe an Cross- Border Banks ................................................................................................................................151 EUGENIO CERUTTI • ANNA ILYINA • YULIA MAKAROVA • CHRISTIAN SCHMIEDER 12. Conducting Stress Tests of Defi ned Benefi t Pension Plans .....................................................183 GREGORIO IMPAVIDO B. THE NETWORK ANALYSIS APPROACH 13. Introduction to the Network Analysis Approach to Stress Testing ......................................205 MARCO A. ESPINOSA VEGA • JUAN SOLÉ 14. Cross- Border Financial Surveillance: A Network Perspective .................................................209 MARCO A. ESPINOSA VEGA • JUAN SOLÉ 15. Balance Sheet Network Analysis of Too- Connected- to- Fail Risk in Global and Domestic Banking Systems .....................................................................................229 JORGE A. CHANL AU PART II THE MARKET PRICE BASED APPROACH A. THE EQUITY INDICATORS BASED APPROACH 16. Introduction to the Equity Indicators– Based Approach to Stress Testing .........................247 JORGE A. CHAN LAU 17. The Global Financial Crisis and Its Impact on the Chilean Banking System .....................249 JORGE A. CHAN LAU 18. Regulatory Capital Charges for Too- Connected-t o- Fail Institutions: A Practical Proposal ...............................................................................................................................263 JORGE A. CHANL AU B. THE EXTREME VALUE THEORY APPROACH 19. Introduction to the Extreme Value Theory Approach to Stress Testing .............................279 SROBONA MITRA 20. External Linkages and Contagion Risk in Irish Banks ................................................................281 ELENA DUGGAR • SROBONA MITRA 21. Identifying Spillover Risk in the International Banking System: An Extreme Value Theory Approach....................................................................................................................................299 JORGE A. CHAN LAU • MARTIN ČIHÁK • SROBONA MITRA • LI LIAN ONG C. THE CONTINGENT CLAIMS ANALYSIS APPROACH 22. Introduction to the Contingent Claims Analysis Approach for Stress Testing .................333 DALE F. GRAY • ANDREAS A. JOBST • CHENG HOON LIM • YINGBIN XIAO 23. Vulnerabilities of House hold and Corporate Balance Sheets in the United Kingdom and Risks for the Financial Sector .....................................................................................................337 MARTA RUIZ ARRANZ ©International Monetary Fund. Not for Redistribution Contents vii 24. Mea sur ing and Analyzing Sovereign Risk with Contingent Claims .....................................359 MICHAEL T. GAPEN • DALE F. GRAY • CHENG HOON LIM • YINGBIN XIAO 25. Factor Model for Stress Testing with a Contingent Claims Model of the Chilean Banking System ..............................................................................................................387 DALE F. GRAY • JAMES P. WALSH 26. Systemic Contingent Claims Analysis .............................................................................................409 ANDREAS A. JOBST • DALE F. GRAY 27. Mea sur ing Systemic Risk-A djusted Liquidity ...............................................................................431 ANDREAS A. JOBST PART III THE MACROFINANCIAL APPROACH 28. Introduction to the Macro-Financial Approach to Stress Testing .........................................449 ANDREA M. MAECHLER 29. A Macro Stress Test Model of Credit Risk for the Brazilian Banking Sector .......................453 FRANCISCO VAZQUEZ • BENJAMIN M. TABAK • MARCOS SOUTO 30. A Practical Example of the Nonperforming Loans Projection Approach to Stress Testing ...........................................................................................................................................473 TORSTEN WEZEL • MICHEL CANTA • MANUEL LUY 31. Portfolio Credit Risk and Macroeconomic Shocks: Applications to Stress Testing under Data- Restricted Environments .............................................................................................485 MIGUEL A. SEGOVIANO • PABLO PADILLA 32. Banking Stability Mea sures ................................................................................................................513 MIGUEL A. SEGOVIANO • CHARLES A. E. GOODHART 33. A Forward- Looking Macroprudential Stress Test for U.S. Banks ............................................531 GEOFFREY N. KEIM • ANDREA M. MAECHLER 34. The Real Eff ects of Financial Sector Risk ........................................................................................561 ALEXANDER F. TIEMAN • ANDREA M. MAECHLER Index 579 TOOLKIT CONTENTS The fi les listed below are available on the companion CD and at www.elibrary.imf.org/stress-test-toolkit. Chapter 3 Stress Tester 3.0 Chapter 4 Excel Spreadsheet Macro for the Breaking Point Method Chapter 5 Excel Spreadsheet Macro for the Next- Generation Solvency Stress Test ©International Monetary Fund. Not for Redistribution viii Contents Chapter 6 Excel Spreadsheet Macro for the Market and Funding Liquidity Stress Test Chapter 7 Excel Spreadsheet Macro for the Next- Generation Systemwide Liquidity Stress Test Chapter 10 Excel Add- in for the CreditRisk+ Model Chapter 12 Excel Spreadsheet Macro for Stress Testing Defi ned Benefi t Pension Plans Chapter 14 Excel- based Program for Bank Network Analysis Chapter 20 Example Eviews Program Codes: External Linkages Chapter 21 Example Eviews Program Codes: International Banking System Chapter 24 Excel Spreadsheet for the Balance Sheet Risk Analysis Chapter 33 Excel Spreadsheet Macro for Forward- Looking Macroprudential Stress Test ©International Monetary Fund. Not for Redistribution Foreword Th e global fi nancial crisis has placed a spotlight on the stress testing of fi nancial systems. Although weaknesses in stress tests were exposed by the crisis, the recent experience of several countries has conversely provided a stark illustration of their poten- tial benefi t in examining the resilience of bank balance sheets when performed credibly and transparently. Nonetheless, the large menu of stress testing approaches, methods, and models raises questions about their appropriate application under diff er- ent situations and, consequently, the comparability and reliability of the associated analyses. Th e International Monetary Fund (IMF) has had a long and unique involvement in the stress testing of fi nancial systems. Since the introduction of the Financial Sector Assessment Program (FSAP) more than a de cade ago, IMF staff has conducted stress tests of banking sectors in over 120 countries, typically in close collaboration with country authorities. Stress testing is also playing an increasingly important role in the IMF’s multilateral surveillance, through the analysis in our Global Financial Stability Report. Separately, member countries are increasingly requesting IMF technical assistance in stress testing as they de- velop their own expertise in this area. As a result, our staff has amassed a wealth of hands- on experience with stress testing techniques and their practical application. Th is book represents a compendium of stress testing methods, models, and tools developed or adapted by IMF staff over the years. Almost all the methods and models that are included in this volume have, at one time or another, been applied in our surveillance of, or our technical assistance to, member countries. To guide users, each chapter off ers a summary describing the application of a method or model, its strengths and weaknesses, and the data requirements. Where available, the stress testing tools or program codes are also provided for wider public use. Although I trust that this volume will provide a valuable resource for policymakers, supervisors, academics, and private sector participants alike, caveats still apply. Th e crisis has underscored that stress tests, irrespective of their level of sophistication, are not fail-s afe, stand-a lone diagnostic tools. Assessments of the soundness of any fi nancial system cannot and should not be based solely on a “model” and must be complemented by other quantitative analyses, qualitative information, and, most important, expert judgment. Especially in light of evolving market practices, risks, and regulatory requirements, stress testing will necessarily continue to be art rather than science. IMF staff is continually working to strengthen the analytical underpinnings of its stress testing, in ways that will help bolster its consistency and comparability and hence its credibility. Key areas of focus include extending the analysis to better cover nonbank fi nancial institutions and infrastructures; to take account of spillovers between institutions and across borders; to con- sider the interaction between liquidity and solvency risks; and to address data gaps. In addition, IMF staff is developing the policy- related aspects of stress testing, namely, “best practice” principles, concepts, and frameworks, to complement and strengthen the application of the models. Th ese eff orts represent a challenging and exciting part of the IMF’s broader support of global eff orts to improve fi nancial surveillance and promote sound macroprudential frameworks. José Viñals Financial Counsellor and Director Monetary and Capital Markets Department International Monetary Fund ©International Monetary Fund. Not for Redistribution