Stress testing COVID-19
This paper provides a stress-test template for financial supervisors to simulate potential losses on banks’ and insurers’ balance sheets under 6 different COVID-19 pandemic scenarios over the next 36 months. It develops the nature of these scenarios and provides loss estimates that can be used as inputs to analysisof banks’ and insurers’ balance sheets. While valuation losses and credit spreads have already moved dramatically in the past month, this paper is not designed to recalculate what is already modelled but rather provide a toolkit for financial supervisors and institutions to scenario plan the next 36 months.
The stress-test scenarios cannot unfortunately enjoy a back office of a team of modellers developing scenarios over time and testing and calibrating them to ensure stress-test scenarios for this pandemic are ready and off the shelf. Unfortunately, financial supervision by and large still remains wedded to traditional stress-test formats without ensuring preparedness to existential and ‘long-term risks’, ofwhich pandemic is one. Long-term risks in this context are in the “point in time” category (see Fig. below), which relates to 1 in 1000 type events which are very unlikely to happen at any given point but very likely to happen at some point.