Generally speaking, “stress testing” is a forward-looking risk management process by which an organization attempts to assess the impact of adverse events or circumstances. It is by no means a novel concept and has been used in the context of financial institutions for many years. However, the impact of the Great Recession on financial institutions’ balance sheets, coupled with the perception that many banks were unprepared for and ill-equipped to withstand the accompanying economic shocks, has resulted in significant legislative and regulatory developments in the area of stress testing.
In February 2009, in the throes of the financial crisis, the federal banking agencies developed a stress test and required the country’s 19 largest bank holding companies with assets exceeding $100 billion to apply it as part of the Supervisory Capital Assessment Program.The SCAP stress test involved two alternative economic
scenarios: a baseline scenario reflecting a consensus expectation among professional forecasters on the depth and duration of the recession, and a more adverse scenario characterizing a recession that was longer and more severe than the consensus expectation.