Stress tests for banks

Extreme stress tests conducted by the HKMA - and by the banks themselves - indicate that Hong Kong's banks are well able to take the pressure.

Hong Kong has an extremely robust banking system, as evidenced by the fact that the banks stood up so well during the Asian financial crisis and are also holding up well in the current economic downturn. But how do we satisfy ourselves that, if things get worse, the banking system will still remain strong? The answer is that we at the HKMA, and indeed the banks themselves, conduct regular "stress-tests" in which we ask ourselves the question, "hypothetically, how would the banks fare if there was a sharp deterioration in general economic conditions, or a big increase in bad debts, or if interest rates rose sharply - or all three?" The technique that is adopted is to devise different scenarios - some plausible and based on past experience, but others which are more extreme and, of course, highly unlikely - and then to estimate how banks' profitability and capital position would be affected in each case. This enables us to gauge how robust and resilient the banking sector would be in different types of situations, and may help identify particular areas of risk on which we need to focus.

As I said, this is a fairly routine regular exercise, but it is one to which we have been paying increasing attention. Indeed, we shall shortly issue a guidance note to the banks setting out in detail some suggestions on how they might further develop their stress-testing. Our guidance note will even set out, as examples, some hypothetical stress scenarios the banks may wish to use. I would hasten to add, however, that these are in no way HKMA "forecasts" of what is likely to happen - they are purely hypothetical "what if?" scenarios for the purposes of conducting stress-testing.

But I cannot leave this subject without saying a little bit about the results of the stress-testing we have been conducting - particularly since, having been made aware of the above information, readers will wish to know next how well the banks do under these stress tests. The results indicate that our banking system would remain robust even under quite extreme and unlikely economic and financial conditions. Even though bank profitability would suffer very significantly under the more extreme scenarios, the solvency of the banking sector would not be threatened. As it is a key policy objective of the HKMA to promote the safety and stability of the banking system, this is reassuring news, both for us and for the Hong Kong public.

Joseph Yam

29 August 2002

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