Global financial institutions need to conduct stress tests in order to ensure that they are able to withstand various financial emergency situations. They want to make sure that they can stay solvent during severe economic challenges.
As a matter of fact, since the 2008 financial crisis, global regulators have issued strict requirements in relation to the type and severity of risk scenarios that financial institutions should use annually.
Stress testing also offers an opportunity to evaluate a company’s operational readiness to respond to a crisis.
For instance, one of the global regulatory bodies, the European Banking Authority (EBA) has the responsibility to ensure the proper functioning of financial markets and the soundness of the financial system in the EU.
In order to do that, EBA “is mandated to monitor and assess market developments as well as to identify trends, potential risks and vulnerabilities stemming from the micro-prudential level.”
EBA’s EU-wise stress tests are carried out in a bottom-up fashion. The organization is utilizing methodologies, scenarios, and key assumptions that were developed in collaboration with the ESRB, the European Central Bank (ECB) and the European Commission (EC).
In the same fashion, the Federal Reserve of the US carries out annual supervisory stress tests of banks with $50 billion or more in assets. The key goal of this stress test is to find out whether a bank has enough capital to properly function during tough times.
Following on this, stress tests at private mortgage lenders are conducted twice a year, as they also have to comply with strict reporting deadlines.