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Stress testing is a vital risk management tool used by banks to assess their resilience to adverse economic and financial conditions. It involves simulating extreme but plausible scenarios to evaluate the potential impact on a bank’s capital, liquidity, and overall financial health. The objective is to identify vulnerabilities in the bank’s portfolio and assess whether it holds sufficient capital buffers to absorb losses under stressed conditions. Stress testing is mandated by regulatory bodies like the Basel Committee on Banking Supervision and national regulators such as the Reserve Bank of India, especially after the global financial crisis of 2008. There are several approaches to conducting stress tests in banking: 1. Scenario Analysis: This method involves constructing hypothetical adverse economic scenarios, such as a sharp decline in GDP, increase in interest rates, or a real estate market crash. The bank _______ __________ _______ _______ ______.
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