A Framework for Stress Testing Bank's Credit Risk
AbstractThis paper develops a framework for stress testing the credit exposures of Hong Kong's retail banks to macroeconomic shocks. It involves the construction of macroeconomic credit risk models, each consisting of a multiple regression model explaining the default rate of banks, and a set of autoregressive models explaining the macroeconomic environment estimated by the method of seemingly unrelated regression. Specifically, two macroeconomic credit risk models are built. One model is specified for the overall loan portfolios of banks and, to illustrate how the same framework can be applied for stress testing loans to different economic sectors, the other model is specified for the banks' mortgage exposures only. The empirical results suggest a significant relationship between the default rates of bank loans and key macroeconomic factors including Hong Kong¡¦s real GDP, real interest rates, real property prices and Mainland China's real GDP. Macro stress testing is then performed to assess the vulnerability and risk exposures of banks' overall loan portfolios and mortgage exposures. By using the framework, a Monte Carlo method is applied to estimate the distribution of possible credit losses conditional on an artificially introduced shock. Different shocks are individually introduced into the framework for the stress tests. The magnitudes of the shocks are specified according to those occurred during the Asian financial crisis. The result shows that even for the Value-at-Risk (VaR) at the confidence level of 90%, banks would continue to make a profit in most stressed scenarios, suggesting that the current credit risk of the banking sector is moderate. However, under the extreme case for the VaR at the confidence level of 99%, banks' credit loss would range from a maximum of 3.22% to a maximum of 5.56% of the portfolios, and if a confidence level of 99.9% is taken, it could range from a maximum of 6.08% to a maximum of 8.95%. These estimated maximum losses are very similar to what the market experienced one year after the Asian financial crisis shock. However, the probability of such losses and beyond is very low.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Hong Kong Monetary Authority in its series Working Papers with number 0615.
Length: 22 pages
Date of creation: Oct 2006
Date of revision:
Contact details of provider:
Postal: 55th Floor, Two International Finance Centre, 8 Finance Street, Central
Web page: http://www.info.gov.hk/hkma/
More information through EDIRC
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-09-09 (All new papers)
- NEP-BAN-2007-09-09 (Banking)
- NEP-CNA-2007-09-09 (China)
- NEP-MAC-2007-09-09 (Macroeconomics)
- NEP-RMG-2007-09-09 (Risk Management)
- NEP-SEA-2007-09-09 (South East Asia)
You can help add them by filling out this form.
reading list or among the top items on IDEAS.Access and download statisticsgeneral information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Simon Chan).
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.