If you Google ‘stress test’, you’ll most likely see a person on a treadmill, hooked up to electrodes, with an ECG monitoring his or her heart. A stress test for a financial institution is similar: it puts the firm under strain and tests whether it is healthy enough to cope.
From a risk management point of view, stress-testing is a good thing. It’s forward-looking and provides insights into the risk-taking of a bank in a way that is impossible using static financial accounting data. Moreover,