Thoughts on the proper design of macro stress tests

This paper provides an introduction to macro stress tests and argues that these exercises could be an important part of enhanced macroprudential policies. Macro stress tests are executed by financial sector supervisors and central banks usually with (1) the aid of key financial institutions and (2) objectives that are different to those of stress tests run by financial firms for internal risk management purposes. For example, macro stress tests were undertaken during the recent international financial crisis with the aim of restoring confidence in financial systems (Bank of England (2008); Board of Governors of the Federal Reserve System (2009a, 2009b); Committee of European Banking Supervisors (2010)). Macro stress tests are also conducted during “good times” to search for potential sources of systemic risk. No matter when they are undertaken, macro stress tests usually estimate the losses that a group of financial institutions considered key to the proper functioning of a financial system, usually a group of large banks, could suffer under adverse macroeconomic developments or other shocks.