Foundations of system-wide financial stress testing with heterogeneous institutions

J. Farmer, Alissa M Kleinnijenhuis (), Paul Nahai-Williamson () and Thom Wetzer ()
Additional contact information
Alissa M Kleinnijenhuis: Institute for New Economic Thinking, University of Oxford, UK and MIT Sloan School of Management, Massachusetts Institute of Technology,
Paul Nahai-Williamson: Bank of England, Postal: Bank of England, Threadneedle Street, London, EC2R 8AH
Thom Wetzer: Faculty of Law, University of Oxford

No 861, Bank of England working papers from Bank of England

Abstract: We propose a structural framework for the development of system-wide financial stress tests with multiple interacting contagion, amplification channels and heterogeneous financial institutions. This framework conceptualises financial systems through the lens of five building blocks: financial institutions, contracts, markets, constraints, and behaviour. Using this framework, we implement a system-wide stress test for the European financial system. We obtain three key findings. First, the financial system may be stable or unstable for a given microprudential stress test outcome, depending on the system’s shock-amplifying tendency. Second, the ‘usability’ of banks’ capital buffers (the willingness of banks to use buffers to absorb losses) is of great consequence to systemic resilience. Third, there is a risk that the size of capital buffers needed to limit systemic risk could be severely underestimated if calibrated in the absence of system-wide approaches.

Keywords: Systemic risk; stress testing; financial contagion; financial institutions; capital requirements; macroprudential policy (search for similar items in EconPapers)
JEL-codes: C63 G17 G21 G23 G28 (search for similar items in EconPapers)
Pages: 83 pages
Date: 2020-05-14
New Economics Papers: this item is included in nep-ban, nep-cba, nep-cfn, nep-ore and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (16)

Downloads: (external link)
https://www.bankofengland.co.uk/-/media/boe/files/ ... ous-institutions.pdf Full text (application/pdf)

Related works:
Working Paper: Foundations of system-wide financial stress testing with heterogeneous institutions (2020)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:boe:boeewp:0861

Access Statistics for this paper

More papers in Bank of England working papers from Bank of England Bank of England, Threadneedle Street, London, EC2R 8AH. Contact information at EDIRC.
Bibliographic data for series maintained by Digital Media Team ().