Stress Testing Interconnected Banking Systems

The recent financial crisis turned the spotlight on the issue of stress testing financial institutions. Until the crisis, risk monitoring and stress testing were built around the safety and soundness of individual institutions. In the aftermath of the crisis, stress tests adopted a new role by incorporating elements of the increased interconnectedness among banks, brokers, insurance companies, and hedge funds. Indeed, for many years after the crisis, stress test models failed to incorporate this interconnectedness and the amplification of distress triggered by financial sector institutions.