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The adoption of stress testing: Why the Basel capital measures were not enough

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  • Larry D Wall

Abstract

The Basel capital adequacy ratios lost credibility with financial markets during the financial crisis. This article argues that the failure was because of the reliance of the Basel standards on overstated asset values in reported equity capital. The US stress tests were able to assist in restoring credibility, in part because they could capture deterioration in asset values. However, whether stress tests will prove equally valuable in the next crisis is not clear. Only some of the weaknesses in the Basel ratios are being addressed. Moreover, the US tests’ success was because of a combination of circumstances that may not exist next time.

Suggested Citation

  • Larry D Wall, 2014. "The adoption of stress testing: Why the Basel capital measures were not enough," Journal of Banking Regulation, Palgrave Macmillan, vol. 15(3-4), pages 266-276, September.
    • Handle: RePEc:pal:jbkreg:v:15:y:2014:i:3-4:p:266-276
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    Cited by:

    1. Pierluigi Bologna & Anatoli Segura, 2017. "Integrating Stress Tests within the Basel III Capital Framework: A Macroprudentially Coherent Approach," Journal of Financial Regulation, Oxford University Press, vol. 3(2), pages 159-186.
    2. Mercy Berman DeMenno, 2023. "Environmental sustainability and financial stability: can macroprudential stress testing measure and mitigate climate-related systemic financial risk?," Journal of Banking Regulation, Palgrave Macmillan, vol. 24(4), pages 445-473, December.
    3. Edward Kane, 2018. "Double Whammy: Implicit Subsidies and the Great Financial Crisis," Working Papers Series 81, Institute for New Economic Thinking.
    4. Herring, Richard J., 2018. "The Evolving Complexity of Capital Regulation," Working Papers 18-01, University of Pennsylvania, Wharton School, Weiss Center.
    5. Wall, Larry, 2014. "Measuring capital adequacy: supervisory stress-tests in a Basel world," Journal of Financial Perspectives, EY Global FS Institute, vol. 2(1), pages 85-94.
    6. Richard J. Herring, 2018. "The Evolving Complexity of Capital Regulation," Journal of Financial Services Research, Springer;Western Finance Association, vol. 53(2), pages 183-205, June.
    7. Bertrand Candelon & Mr. Amadou N Sy, 2015. "How Did Markets React to Stress Tests?," IMF Working Papers 2015/075, International Monetary Fund.

    More about this item

    JEL classification:

    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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