Response to Financial Crises: The Development of Stress Testing over Time

Iftekhar Hasan, David Lynch and Akhtar Siddique

The seemingly simple idea of identifying what would happen to the portfolio of a bank if a particular event happens has become an elaborate and complex undertaking by financial institutions. In this chapter, we will look at how this straightforward concept has evolved since the thrift crisis of the 1980s. The simple approach of identifying what would happen if interest rates changed in a particular way has developed into a tool that can determine capital requirements and inform investors of the weaknesses of a bank, as well as to distinguish weaknesses in the financial system as a whole.

THE THRIFT CRISIS AND INTEREST RATE RISK

The earliest forms of firm-wide stress testing occurred in the area of interest rate risk. In the early 1980s, many savings and loans suffered large losses after interest rates rose sharply, setting off the thrift crisis that eventually required a US$150 billion taxpayer bailout (Curry and Shibut, 2000). The large losses suffered by the thrifts can be partially attributed to the large mismatch in maturity between short-term deposits and long-term loans. As a result, the savings and loan crisis of the 1980s spurred an improvement in the measurement of

To continue reading...

You need to sign in to use this feature. If you don’t have a Risk.net account, please register for a trial.

Sign in
You are currently on corporate access.

To use this feature you will need an individual account. If you have one already please sign in.

Sign in.

Alternatively you can request an individual account here: