The Bank for International Settlements (BIS) has released its report ‘Stress testing in Latin America: A comparison of approaches and methodologies’, which allows central banks of the region to learn from each other’s practices.
The report, which details the different aspects of the stress-testing practices in Latin America countries, aims to test the resilience of institutions and investment portfolios against possible future financial situations via a computer = simulation technique.
The results of the survey found that the LA-7 countries: Argentina, Brazil, Chile, Colombia, Mexico, Peru and Uruguay, pursue similar objectives when running stress tests, and share similar institutional frameworks.
They also share some broad methodological characteristics, such as placing more emphasis on credit risk, and applying this analytical tool in similar ways, the report found.
The report also identified that the approach to communicating stress test results is also similar across jurisdictions.
“At the same time, the common exercise revealed important differences in the ways that the participant authorities implement stress tests, which can lead to significant divergences in the final effects of a stress scenario on the banking sector,” BIS noted in its report.
Elsewhere, BIS said that in terms of the existing framework, Brazil is currently working on its liquidity contagion framework so that it will simulate funding run-offs not only from banks with solvency issues but also from banks similar to the ones with capital concerns.
Colombia indicated that it would benefit from modelling loan and deposit interest rate dynamics more granularly for consistency with the macroeconomic scenario, and incorporating changes to the maturity of assets and liabilities in the banking model, BIS observed.
Meanwhile, BIS explained that Mexico indicates that one area of improvement would be modelling different regimes in terms of variance/covariance estimation for scenario generation.
Additionally, Peru and Uruguay indicated that they would improve their credit risk models, and Peru in particular aims to connect its credit and market satellite.
According to BIS, this with the aim for Peru to improve the mapping of credit risk arising from the exchange rate volatility.
In terms of future work, BIS revealed that Brazil plans to incorporate market liquidity and funding
risks into its top-down stress test with the main aim of measuring spillover effects stemming from risks related to liquidity (funding and market liquidity).
It was highlighted that Peru also mentions plans to include liquidity risk in its stress-testing framework.
Regarding future work for Chile, Mexico and Uruguay, BIS said they aim to include feedback effects, either by extending their existing VAR models for scenario definition, or by developing general equilibrium models to capture the effects between the real and financial sectors.
Peru indicates that it places importance on building market risk models for insurance companies and pension fund portfolios, BIS added.
To review the full report, please click here.
