Stress-Testing Credit Distributions of Banks’ Portfolios: Risk Structure and Concentration Issues

Adolfo Rodríguez, Carlos Trucharte

Preserving stability in the financial system is one of the main functions of financial authorities. Given the importance of banking within the financial system, it is clear that overall financial stability hinges primarily on that of credit institutions.

Specifically the role that banks play within the financial system, through the credit granting function, is essential to properly channel the flow of financial resources between investors and savers. However, this function is not risk-free. Hence, a proper estimation and an accurate assessment of the features of the distribution of banks’ loan loss rates are essential to obtaining an adequate estimate for protection, and also for coverage against potential losses of banks in their ordinary business.

In this regard financial authorities articulate different mechanisms for achieving the goal of financial stability. In particular, the application of prudential and effective supervision must ensure that banks observe the rules, standards and codes of prudence, which provides them with appropriate levels for the key variables that determine their solvency.

It is in relation to determining how loan loss distributions may be affected