In its latest Financial Stability Review, released on Friday (13 October), the RBA has announced its intention to supplement the stress testing of the major banks conducted periodically by APRA with its own set of “top-down” tests.
APRA currently conducts “bottom-up” stress tests on the major banks by asking each institution to determine the impact of a common scenario on their balance sheets.
“These stress tests usually focus on the impact on individual institutions rather than risks to the system as a whole,” the RBA said.
Top-down stress tests, in contrast, typically involve central banks and other public authorities using their own models to estimate the impact of a scenario on the banking system without any involvement from individual banks, the paper said.
While these types of tests allow central banks to test more scenarios, they inevitably provide less granular data.
“The top-down framework is more transparent to the public authorities as it can clearly identify how shocks propagate through a bank’s balance sheet,” the RBA said.
“This framework can be extended to capture systemic aspects of bank stress, such as flow-on effects to the financial system as a whole and amplification of economic downturns.
“This is consistent with the Reserve Bank’s focus on risks affecting the whole banking sector, rather than bank-specific risks that are the focus of prudential regulators.”