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Of Runes and Sagas; Perspectives on Liquidity Stress Testing Using an Iceland Example

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  • Martin Cihak
  • Li L Ong

Abstract

The global financial crisis revealed weaknesses in the stress testing exercises performed on financial institutions and systems around the world. These failures were most evident in the area of liquidity risk, where now-obvious vulnerabilities were left largely undetected, with stress tests having largely focused on solvency risk. This paper uses publicly available data from a now-defunct bank in Iceland, where liquidity shocks were immense, to demonstrate how a combination of stress tests of the various risks would have provided a clearer picture of existing vulnerablities. We show that, ultimately, stress test models do not necessarily need to be complex or overly sophisticated. Basic stress tests, using appropriate assumptions and shocks, could reveal key areas of risk to inform contingency planning. The liquidity stress test templates used in this paper are included.

Suggested Citation

  • Martin Cihak & Li L Ong, 2010. "Of Runes and Sagas; Perspectives on Liquidity Stress Testing Using an Iceland Example," IMF Working Papers 10/156, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:10/156
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    Cited by:

    1. Borio, Claudio & Drehmann, Mathias & Tsatsaronis, Kostas, 2014. "Stress-testing macro stress testing: Does it live up to expectations?," Journal of Financial Stability, Elsevier, vol. 12(C), pages 3-15.
    2. Eugenio M Cerutti & Christian Schmieder, 2012. "The Need for "Un-consolidating" Consolidated Banks' Stress Tests," IMF Working Papers 12/288, International Monetary Fund.

    More about this item

    Keywords

    External shocks; Liquidity; Iceland; Stress testing; Funding gap; liquidity risk; liquidity shocks; solvency risk; stress tests; banking; financial institutions; bonds; hedging; banking sector;

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