Stress Testing and Retail Portfolios

Soner Tunay and Rosa Català

Loss forecasting for consumer products has been practised by many leading institutions for a long time. However, regulatory demands have expanded this process by linking forecasts to macroeconomic drivers, integrating them into an enterprise-wide exercise and further using the forecast results as an assessment of capital adequacy. Stress testing embodies two aspects: a macroprudential supervision aspect, allowing regulators to gain a horizontal view of the banking system; and a microprudential risk assessment aspect, for banks to assess their own product and portfolio risk. The best application of the stress-testing framework in financial institutions will at least satisfy the regulatory requirements, and extends the use of the framework to business applications. This chapter will discuss the application of stress testing for consumer portfolios both from a methodology and firm-wide application standpoint, and is aimed at practitioners and modellers, including risk professionals and the portfolio managers.

The design of the framework here is limited to the assets side of the balance sheet, in particular to loans and credit lines such as cards and home equity lines of credit. While