Navigating Banking Resilience: Bail-ins & Bailouts in the Czech Banking Sector

How much capital is truly enough to shield banks from default? Understanding this threshold is critical for designing regulatory frameworks that balance financial stability with economic growth. This paper develops a reverse stress testing framework to assess the resilience of the banking sector under extreme credit shocks. It focuses on the conditions under which banks facing distress transition from bail-ins to government bailouts, using the Czech banking sector as a case study. Our findings indicate that a capital ratio of 23.5% is sufficient to absorb losses comparable to the most severe stress experienced during the Global Financial Crisis (GFC), preventing the need for public intervention. Moreover, we show that regulatory capital buffers are well-calibrated, covering losses up to the second-largest stress event observed in the GFC. Unlike many reverse stress testing approaches, our model explicitly accounts for the dynamic effects of risk-weighted asset (RWA) adjustments, revealing that static RWA assumptions may overestimate capital resilience. These results provide critical insights for policymakers, suggesting that capital adequacy requirements remain well-calibrated but warrant further scrutiny regarding how risk weights evolve under stress conditions.