IDEAS home Printed from
   My bibliography  Save this paper

A Framework for Stress Testing Bank's Credit Risk


  • Jim Wong

    (Research Department, Hong Kong Monetary Authority)

  • Ka-fai Choi

    (Research Department, Hong Kong Monetary Authority)

  • Tom Fong

    (Research Department, Hong Kong Monetary Authority)


This 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.

Suggested Citation

  • Jim Wong & Ka-fai Choi & Tom Fong, 2006. "A Framework for Stress Testing Bank's Credit Risk," Working Papers 0615, Hong Kong Monetary Authority.
  • Handle: RePEc:hkg:wpaper:0615

    Download full text from publisher

    File URL:
    Download Restriction: no

    References listed on IDEAS

    1. Nelson, Daniel B, 1991. "Conditional Heteroskedasticity in Asset Returns: A New Approach," Econometrica, Econometric Society, vol. 59(2), pages 347-370, March.
    2. repec:eee:jbfina:v:83:y:2017:i:c:p:135-152 is not listed on IDEAS
    3. Patrick McGuire & Goetz von Peter, 2009. "The US dollar shortage in global banking," BIS Quarterly Review, Bank for International Settlements, March.
    4. McAndrews, James & Sarkar, Asani & Wang, Zhenyu, 2017. "The effect of the term auction facility on the London interbank offered rate," Journal of Banking & Finance, Elsevier, vol. 83(C), pages 135-152.
    5. Joseph E. Gagnon & Alain P. Chaboud, 2007. "What can the data tell us about carry trades in Japanese yen?," International Finance Discussion Papers 899, Board of Governors of the Federal Reserve System (U.S.).
    6. François-Louis Michaud & Christian Upper, 2008. "What drives interbank rates? Evidence from the Libor panel," BIS Quarterly Review, Bank for International Settlements, March.
    7. Adrian, Tobias & Shin, Hyun Song, 2010. "Liquidity and leverage," Journal of Financial Intermediation, Elsevier, vol. 19(3), pages 418-437, July.
    8. Markus K. Brunnermeier & Stefan Nagel & Lasse H. Pedersen, 2009. "Carry Trades and Currency Crashes," NBER Chapters,in: NBER Macroeconomics Annual 2008, Volume 23, pages 313-347 National Bureau of Economic Research, Inc.
    Full references (including those not matched with items on IDEAS)


    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.

    Cited by:

    1. Cağatay Başarır, 2016. "A Macro Stress Test Model of Credit Risk for the Turkish Banking Sector," Asian Economic and Financial Review, Asian Economic and Social Society, vol. 6(12), pages 762-774, December.

    More about this item

    NEP fields

    This paper has been announced in the following NEP Reports:


    Access and download statistics


    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:hkg:wpaper:0615. 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: (Simon Chan). General contact details of provider: .

    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.

    We have no references for this item. You can help adding them by using 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 RePEc Author Service 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.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.