Regulators and investors alike need stressed scenario analyses from financial institutions to gain a sense of their strength and exposures
COVID-19 has shut down large segments of the economy despite complete lockdowns being lifted in most countries, since negative effects caused by the disruption in supply chains and social-distancing restrictions has caused the risk of mass loan defaults to continue to mount. Now, with renewed fears of another banking crisis, investors are shifting their focus to financial institutions capable of navigating it.
The current crisis is difficult to forecast using historical data since there are no records of a previous situation, how long it will last, and how widely it has been spread. Therefore, it is important to recognize the role stress testing can have in improving the financial system’s strength, and how such results can help us prepare and plan for the worst. This article proposes a statistical framework to address potential stress testing requirements by regulators.
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