Capital Adequacy Pre- and Post-Crisis and the Role of Stress Testing

The financial crisis forced the development of new approaches for determining capital adequacy in banks since extant methods clearly did not prepare banks nor their supervisors sufficiently. The success of stress testing as a crisis response tool, particularly in the US in 2009, has led to its adoption post crisis as the tool of choice for assessing capital adequacy in banks and testing resiliency to economic and financial shocks. But the increased reliance on stress testing in financial peacetime has given rise to a new risk concentration, namely in the rather narrow set of scenarios and their translation to outcomes and impact on bank financials.