Risk Management and Stress Testing in Financial Institutions

In the effort by the United States (U.S.) government to recapitalize failed financial institutions, it has increased its debt-to-GDP ratio. As a result, the U.S. government is forcing the financial institutions to begin a process of financial deleveraging and reconstructing their balance sheets; the need to raise capital is a primary focus instead of expanding their credit lines. This credit contraction deteriorates economic activity in the country. Unfortunately, the recovery of the U.S. financial system will be very costly and will take some time. As a result, the U.S. government is forcing the financial institutions to begin a process of financial deleveraging and reconstructing their balance sheets; the need to raise capital is a primary focus instead of expanding their credit lines. This credit contraction deteriorates economic activity in the country. Unfortunately, the recovery of the U.S. financial system will be very costly and will take some time.

As a team of graduate students at Columbia University’s School of International and Public Affairs (SIPA), the team was engaged in a Capstone project beginning in September 2009 on the topic of financial risk management and stress testing at financial institutions. The main objective of the project is to gain a better understanding of the changes in risk management measurement that financial institutions and regulators have adopted since the crisis. This understanding will ultimately shed light on the changing environment of risk management and some of the better practices adopted by financial institutions in monitoring risks.