Stress testing - Financial definition
Concise definition of the term stress testing
Stress testing in finance is a risk management technique used to evaluate how a financial institution or portfolio would perform under adverse economic conditions. It involves simulating various hypothetical scenarios to identify vulnerabilities and ensure resilience against potential shocks.
Comprehensive definition of the term stress testing
Stress testing forms a crucial part of foreign reserves management, where central banks assess the stability and adequacy of reserves under extreme market conditions. This process involves creating and analyzing hypothetical scenarios such as severe economic recessions, financial crises, or geopolitical events. For example, a central bank might simulate the impact of a sudden devaluation of its currency or a significant drop in commodity prices on its foreign reserves. These tests help institutions develop contingency plans, adjust their risk exposures, and ensure they have sufficient liquidity to maintain economic stability. Stress testing has become a standard practice in financial regulation, helping to enhance the robustness of financial systems globally.