Liquidity Risk: The Case of the Brazilian Banking System

Benjamin M Tabak, Solange M Guerra, Sergio RS Souza and Rodrigo CC Miranda

Stress tests are already a widely used tool for risk management of financial institutions. Central banks and individual banks run these tests for determining potential risk sources that they might encounter in scenarios of severe change in the macroeconomic situation and assessing their resilience to such events. By testing themselves or the financial system as a whole beyond normal operational capacity, they can quantify vulnerabilities, and the stability of the given system or entity may be studied and pursued more easily (Vazquez, Tabak and Souto 2012).

To design and apply a stress test, many important assumptions should be taken. The first step must be identifying the specific risk and vulnerability of concern. In the literature about stress testing of banking risks, the most common type of risks considered are credit, market and liquidity. The majority of papers have focused on assessing credit risk, since this is the bank’s most important risk component. However, liquidity stress testing is getting more visibility and importance.

Although liquidity crises are not so frequent, their impacts are high (low-frequency, high-impact events), especially due to their contagious