What is stress testing?

Hi, my name’s Noor and I work at the Bank
of England. Here at the Bank of England, we need to
keep an eye on how banks would cope with difficult
economic situations. We do this by stress testing banks
against various hypothetical scenarios. The Bank of England then ensures
that should these situations occur, banks hold sufficient capital
to meet unexpected losses. From 2016, we will use two ‘What if’ scenarios
to test banks. The first will be a yearly test of shock scenarios
with different levels of severity, based on the UK’s current economic cycle. The ‘annual cyclical’ scenario
could include falls in output or house prices, or increases in interest rates or unemployment. The second will be an ‘exploratory’ scenario
every two years. This scenario will look at risks that are unlikely to happen, but are still a concern. For example, what might happen if a large bank fails. Banks have always been required to hold a
minimum amount of capital to absorb losses. But from 2016 how the Bank of England looks
at stress test performance is changing… with larger and more risky banks needing to
carry more loss-absorbing capital. Should a bank not perform satisfactorily,
the Bank of England has a range of powers, such as requiring the bank to take action to strengthen its capital position within a certain period of time.

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