Template-Type: ReDIF-Paper 1.0
Title: Foundations of system-wide financial stress testing with heterogeneous institutions
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.
Author-Name: Farmer, J. Doyne
Author-Name: Kleinnijenhuis, Alissa
Author-Name: Nahai-Williamson, Paul
Author-Name: Wetzer, Thom
File-URL: https://oms-inet.files.svdcdn.com/production/files/foundations-of-system-wide-financial-stress-testing-with-heterogeneous-institutions-copy.pdf
File-Format: Application/pdf
File-Function: 
Keywords: Systemic risk, stress testing, financial contagion, financial institutions, capital requirements, macroprudential policy
Length: 84 pages
Classification-Jel: G17, G21, G23, G28, C63.
Creation-Date: 2020-05
Handle: RePEc:amz:wpaper:2020-14