Stress testing: The impact of shocks on the capital needs of the Luxembourg banking sector
We use data on loan loss provisions and total loans over the period spanning 1995 until 2009 to estimate a stress testing model for the Luxembourg banking sector. The sample encompasses the recent global crisis and covers a period in which the average probability of default of the Luxembourg banking sector?s counterparties is observed to increase significantly. A joint model, consisting of several macroeconomic variables and the logit-transformed probability of default, is specified and estimated via seemingly unrelated regression (SUR). The results suggest that counterparty default rates are significantly affected by the euro area real GDP growth rate, the real interest rate and a domestic property price index. Conversely, changes in the Luxembourg real GDP growth rate have a much smaller effect on counterparty risk. We attribute this to the large number of foreign subsidiaries operating within Luxembourg. The estimated model is then used to simulate values of the probability of default and the macroeconomic variables over a horizon of 10 quarters. This allows us to construct distributions for the probability of default under both baseline and adverse scenarios. From the results of these simulations stressed Basel II tier 1 capital ratios are calculated and compared to their associated unstressed capitalization levels. Our calculations suggest that, under all the given adverse macroeconomic scenarios, the aggregate Luxembourg financial sector remains above the 4% minimum Basel II tier 1 capital requirement. Repeating the exercise on a limited sample of 5 individual banks produces similar results.
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Charles A.E. Goodhart & Pojanart Sunirand & Dimitrios P. Tsomocos, 2003.
"A Model to Analyse Financial Fragility,"
OFRC Working Papers Series
2003fe13, Oxford Financial Research Centre.
- Dimitrios P Tsomocos & Charles A.E. Goodhart, 2003. "A Model to Analyse Financial Fragility," Economics Series Working Papers 2003-FE-13, University of Oxford, Department of Economics.
- Charles Goodhart & Pojanart Sunirand & Dimitrios P. Tsomocos, 2004. "A model to analyse financial fragility," LSE Research Online Documents on Economics 24703, London School of Economics and Political Science, LSE Library.
- Gregory DE WALQUE & Olivier PIERRARD & Abdelaziz ROUABAH, 2009.
"Financial (in)stability, supervision and liquidity injections : a dynamic general equilibrium approach,"
Discussion Papers (IRES - Institut de Recherches Economiques et Sociales)
2009006, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).
- Gregory deWalque & Olivier Pierrard & Abdelaziz Rouabah, 2010. "Financial (In)Stability, Supervision and Liquidity Injections: A Dynamic General Equilibrium Approach," Economic Journal, Royal Economic Society, vol. 120(549), pages 1234-1261, December.
- de Walque, Gregory & Pierrard, Olivier & Rouabah, Abdelaziz, 2009. "Financial (In)stability, Supervision and Liquidity Injections: A Dynamic General Equilibrium Approach," CEPR Discussion Papers 7202, C.E.P.R. Discussion Papers.
- Gregory de Walque & Olivier Pierrard & Abdelaziz Rouabah, 2008. "Financial (in)stability, supervision and liquidity injections: a dynamic general equilibrium approach," BCL working papers 35, Central Bank of Luxembourg.
- Gregory de Walque & Olivier Pierrard & Abdelaziz Rouabah, 2008. "Financial (in)stability, supervision and liquidity injections : a dynamic general equilibrium approach," Working Paper Research 148, National Bank of Belgium.
- Hans Degryse & Grégory Nguyen, 2004.
"Interbank exposures: an empirical examination of systemic risk in the Belgian banking system,"
Working Paper Research
43, National Bank of Belgium.
- Degryse, H.A. & Nguyen, G., 2004. "Interbank Exposures : An Empirical Examination of Systemic Risk in the Belgian Banking System," Discussion Paper 2004-4, Tilburg University, Center for Economic Research.
- Glenn Hoggarth & Steffen Sorensen & Lea Zicchino, 2005. "Stress tests of UK banks using a VAR approach," Bank of England working papers 282, Bank of England.
- Thomas Breuer & Martin Jandacka & Klaus Rheinberger & Martin Summer, 2009.
"How to Find Plausible, Severe and Useful Stress Scenarios,"
International Journal of Central Banking,
International Journal of Central Banking, vol. 5(3), pages 205-224, September.
- Thomas Breuer & Martin Jandacka & Klaus Rheinberger & Martin Summer, 2009. "How to find plausible, severe, and useful stress scenarios," Working Papers 150, Oesterreichische Nationalbank (Austrian Central Bank).
- Charles A. E. Goodhart & Carolina Osorio & Dimitrios P. Tsomocos, 2009. "Analysis of Monetary Policy and Financial Stability: A New Paradigm," CESifo Working Paper Series 2885, CESifo Group Munich.
- Paul Louis Ceriel Hilbers & Matthew T. Jones & Graham L. Slack, 2004. "Stress Testing Financial Systems: What to Do When the Governor Calls," IMF Working Papers 04/127, International Monetary Fund.
- Illing, Mark & Liu, Ying, 2006. "Measuring financial stress in a developed country: An application to Canada," Journal of Financial Stability, Elsevier, vol. 2(3), pages 243-265, October.
When requesting a correction, please mention this item's handle: RePEc:bcl:bclwop:bclwp047. See general 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: ()
If references are entirely missing, you can add them using this form.