Integrated Stress Testing: From Credit to Liquidity Risk

Recent bank failures have highlighted flaws in the typical risk management approach. Banks should mobilize to address these flaws, such as the lack of integrated stress testing. Although banks in general conduct interest rate, credit, market, and liquidity stress testing for regulatory compliance, they do so separately within each risk silo, and they therefore do not take into account ripple effects across risk types. The bank failures have revealed how the interaction of credit and liquidity risks can aggravate default risk. Thus, in this talk we will discuss how credit, liquidity, and collateral related shocks could be incorporated into stress tests, and we will illustrate how such shocks can simultaneously affect earnings, capital, and liquidity ratios of a bank.