Risk Management and Stress Testing in Financial Institutions

The effects of the global financial crisis that began in 2008 sparked a heightened and evolving regulatory debate in Washington, much of which revolves around risk-taking at financial institutions. In light of this debate, the Capstone team had undertaken a study on behalf of the Congressional Research Service (CRS) to examine risk management at financial institutions, with a particular focus on stress testing.

The crisis highlighted the importance for financial institutions of protecting themselves against extreme market disruptions. Needless to say, crises are extremely costly for taxpayers and contribute to the deterioration of socioeconomic conditions in a country. The recent crisis has also exposed weaknesses in the risk management techniques and policies across many financial institutions. It is therefore crucial that financial institutions incorporate perspicacious risk management techniques to identify risks in conducting daily business as well as in the case of negative shocks. 

The main objective of the project is to gain an understanding of how risk management works in practice. In doing so, the project offers an opportunity to better understand how risk management has changed in response to the crisis. In particular, the interviews with risk managers shed light on issues such as risk management methodology and stress testing, systemic risk, and views on regulators. This understanding will ultimately highlight the changing environment of risk management and some of the practices adopted by financial institutions in this space.