Stress Testing and Calibration of Macroprudential Policy Tools

IMF Working Papers, August 14, 2020

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Presents a semi-structural model of default risk as a function of loan and borrower characteristics, economic conditions, and the regulatory environment.
Uses the model to simulate bank credit losses for stress-testing purposes and to calibrate borrower-based macroprudential tools.
Emphasizes flexibility for situations with limited crisis history, unanticipated shocks, or structural/regulatory changes altering the loan default process.
Applies the model to quantify mortgage lending risk in two distinct mortgage markets.
Model features enable counterfactual analysis and evaluation of macroprudential policy interventions.

Core construct: semi-structural default-risk model dependent on loan characteristics, borrower characteristics, economic conditions, and regulatory environment.
Input data: bank portfolio data broken down by risk bucket and vintage, enabling explicit account of the loan life cycle.
Incorporates housing and economic cycles to simulate portfolio-level credit losses.
Suitable for stress-testing and for calibrating borrower-based macroprudential tools.
Particularly useful when:
- There is limited history of crisis episodes.
- Crises bring unanticipated shocks where past tail events offer little guidance.
- Structural shocks or changes in financial regulations have altered the loan default process.

Applied to mortgage lending risk in two distinct mortgage markets.
For each application, the paper demonstrates a range of modeling adjustments to capture country-specific institutional features.
Use of vintage and risk-bucket breakdown allows:
- Explicit loan life-cycle modeling.
- Incorporation of housing and economic cycle dynamics.
- Timely assessment of banks’ loss-absorbing capacity and buildup of systemic risk conditional on policy.

Facilitates stress-testing to estimate bank credit losses under alternative scenarios.
Enables calibration of borrower-based macroprudential tools.
Supports counterfactual analysis to evaluate macroprudential policy interventions.
Helps assess systemic risk accumulation and banks’ capacity to absorb losses conditional on policy choices.