Stress testing is a risk management tool that helps
decision-makers evaluate the resilience of a given entity or the financial
system as a whole in the worst-case scenario. Stress testing is widely used by
regulators and risk managers of banks and financial institutions to assess the
potential impacts of plausible severe future events.
Stress testing came to the fore as a crucial tool
for regulators and risk managers of banks and financial institutions during the
2008-09 financial crisis. Central banks periodically conduct such tests to
assess the resilience of the financial system and its individual components
against various macroeconomic and financial risks. This process includes
quantitatively evaluating whether bank capital would fall below given
thresholds if certain risks were to materialize.