Stress testing

What is stress testing?

Stress testing is a method of quantitative financial market analysis used to assess the resilience of individual banks and the banking system as a whole. It involves the design of (stress) scenarios and the analysis of the impact of those scenarios. Supervisors use stress tests to evaluate the capitalization and liquidity situation of individual banks, comparing hypothetical losses – under the assumptions of the relevant scenario – with existing buffers. Apart from that, stress tests are also applied in financial stability analysis to assess systemic risk, in particular interactions between individual banks. Here, the impact on the entire banking system of stress scenarios for the real economy are investigated; therefore, these stress tests are also called macro stress tests.

Current stress test results

The stress test scenarios chosen by supervisors should be severe but plausible. They should simulate a serious threat to banks’ viability while being realistic and credible at the same time. At the OeNB, developing the scenarios for Austria, Europe and the rest of the world, taking into account the characteristics of the Austrian banking system, is therefore a joint effort of the divisions dealing with banking supervision, macroeconomic and financial stability issues. These jointly developed scenarios are the basis for the calculation of risk factors, such as credit defaults or house price shocks. The scenarios are not only limited to typical economic crises, but also reflect the COVID-19 pandemic or the effects of carbon taxation.

Large-scale stress tests receive public attention, which contributes to substantial capital increases both in the run-up to the test and after results have been published, and therefore also improve banks’ resilience. Despite the high expectations placed in stress tests, it should be borne in mind that stress testing is not a panacea for financial stability problems, but a method of quantitative financial market analysis.

A brief history of stress testing

Banks first used stress tests in market risk management. In the 1990s, stress tests were carried out to calculate valuation effects in the case of adverse price developments, e.g. interest rate or exchange rate movements.

Stress testing as it is carried out today has been promoted on a global scale especially by the International Monetary Fund (IMF) under its Financial Sector Assessment Program (FSAP). In Austria, it was under the first FSAP in 2003 that the OeNB conducted its first large-scale stress test. Much of the earlier research work fed into this first FSAP stress testing exercise for the Austrian banking system. Numerous scenarios were applied to assess liquidity risk, credit and market risk as well as contagion risk in the domestic banking sector.

The global financial crisis and the bank stress tests conducted in its wake in the USA in 2009 familiarized a broader public with stress testing. In Europe, the European Banking Authority (EBA) and the European Systemic Risk Board (ESRB) jointly coordinate stress tests comparable to those conducted in the USA. Carrying out these stress tests is the responsibility of the ECB and the national supervisory authorities, i.e. in Austria the OeNB and the Financial Market Authority (FMA). Such an international exercise requires a large amount of coordination. However, the effort pays off: Supervisors, market participants and the general public benefit from comparable data and consistent risk assessments.

In 2007, the OeNB for the first time involved banks in the calculation of macro stress tests. Between 2007 and 2014, banks used to run bottom-up stress tests whereas the OeNB would run top-down stress tests, analyzing the selected scenarios in parallel. This approach has since become best practice in and outside of Austria. Since the ECB became responsible for supervising the largest banks, bottom-up stress tests for these banks have been conducted by the ECB, while the OeNB continues to run top-down stress tests for the national banking sector as a whole. To this end, the OeNB implemented ARNIE (Applied Risk Network and Impact Assessment Engine) in 2013, which continues to be used frequently in supervisory activities today.

At the international level, stress testing models are increasingly using a dynamic balance sheet approach, as opposed to static balance sheet assumptions. In 2024, the OeNB integrated this approach into its larger stress testing infrastructure. The OeNB publishes aggregated results in its Financial Stability Report. In addition to its annual solvency stress test, the OeNB also publishes analyses covering selected focus areas, such as climate risk stress tests or calculations based on the dynamic balance sheet model.