What is stress testing in finance?

What is stress testing in finance?

Stress testing in finance is a simulation technique used to evaluate how financial institutions can handle extreme market conditions.

Why is stress testing important for banks?

It's crucial for banks to identify vulnerabilities, ensure compliance with regulations, and maintain financial stability during crises.

What are some common scenarios used in stress testing?

Common scenarios include economic downturns, sudden interest rate changes, and significant market shocks.

How often should stress tests be conducted?

Stress tests should be conducted regularly, typically at least annually, and more frequently during volatile market conditions.

Can you give an example of a stress test result?

Sure! For instance, a bank might find that under a severe recession scenario, its capital ratio could drop below regulatory requirements.