A bank stress test is essentially a model or simulation of future events that demonstrates how well an institution might deal with changes in the financial landscape. These tests are often designed to show how predicted or possible changes might impact an organization, usually based on a number of factors and test criteria. A bank stress test can include multiple scenarios and tests, based on what is considered practical, including realistic and “worst case” tests. While a bank can run a test on itself, financial regulators and government institutions also run these tests on a larger scale to see how multiple systems might deal with a crisis.
The purpose of a bank stress test is to create a model of events in order to see how well groups might function in a particular situation. Stress tests in general refer to any type of testing that simulates an event of intensity to see how well systems can function during it. In creating a bank stress test, the people responsible typically look at a number of possibilities for financial situations. Using information about the bank, a simulation is created in which future changes are considered to see how well they might handle that situation.
A bank stress test is usually designed to create a few different scenarios, in order to fully understand what situations an organization can handle. Financial analysts running a test, for example, are likely to use predicted economic forecasts and see how well the bank might deal with that situation. More severe or dire possibilities can then be used to create additional tests that are more like a “worst case scenario.” If an institution is able to get through this type of catastrophic bank stress test, then it is likely to be able to do so should the test model become a reality.
Analysts can perform a bank stress test on one particular institution, using data regarding its current status. Much of this type of testing is never released to the public, but is instead used by an organization to determine possible courses of action for them. A bank stress test can also be performed by a government organization, especially one charged with overseeing and regulating banking for a particular country.
Larger tests often use data from multiple banks and a more robust model to perform a wide-scale analysis. Such testing is difficult and potentially more imprecise than those for individual institutions, but it provides a greater overall view of financial futures. These tests are often released to the public, are intended to boost confidence in an economic system, and demonstrate to certain banks that improvements need to be made.