Stress testing assesses the resilience of banks and insurers to severe but plausible risks, including economic downturns. The results of stress tests help us monitor financial stability and inform our policy decisions. They also help entities manage risk, set capital and liquidity buffers, and improve recovery planning.
In 2024 our solvency stress testing exercise for banks was a reverse stress test. This is very different to our traditional stress test, in which banks estimate the impacts of a common prescribed scenario featuring a severe recession on their balance sheets, profitability and capital ratios. For a reverse stress test, a specific capital outcome is set first. Banks then work in reverse to identify a plausible scenario that would result in that outcome, tailored to their businesses and vulnerabilities.
Key insights
- Several banks identified that a combination of events is most likely to cause a breach of capital minimums. The majority included some form of geopolitical event in their scenarios.
- A handful of critical factors drove large credit losses – unemployment and property prices being the most important.
- Banks are increasingly aware of the risks posed by changes or disruption in the insurance market.
- Banks highlighted the interaction between liquidity and solvency risks. Some banks modelled large increases in funding costs.
- Banks highlighted significant benefits from the exercise, e.g. insights for risk identification, modelling, governance and recovery planning.
