Stress testing bank insolvency risk by systemic equity market shock: An expected shortfall approach

Hank Z. Yang
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Hank Z. Yang: Senior Specialist, Office of the Superintendent of Financial Institutions, Canada

Journal of Risk Management in Financial Institutions, 2023, vol. 16, issue 3, 211-227

Abstract: This paper proposes a simple intuitive approach for assessing and stress testing the insolvency risk of global systemically important banks (G-SIBs) by shocking systemic risk in the equity market. In particular, the paper introduces two metrics to measure the relative adequacy of total loss absorbing capacity (TLAC) upon resolution of a bank under both real market conditions and stress test settings. The metrics may also be calculated on a regular basis for monitoring bank insolvency risk. Three global systemically important banks, including Credit Suisse, are presented as examples for the analysis. To capture the heavy tail feature of equity market downturns and ensure conservatism for stress testing, an analytical framework is adopted based on extreme value theory with expected shortfall, power law distributions and copula method. The analysis concludes that G-SIBs may have a high probability of loss exceeding TLAC under systemic market stress.

Keywords: systemic risk; total loss absorbing capacity (TLAC); stress test; Credit Suisse; expected shortfall; extreme value theory; copula (search for similar items in EconPapers)
JEL-codes: E5 G2 (search for similar items in EconPapers)
Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:aza:rmfi00:y:2023:v:16:i:3:p:211-227

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