175 - Liquidity Stress-Tester: A macro model for stress-testing banks' liquidity risk

DNB Working Papers
Date 14 May 2008

This paper presents a macro stress-testing model for market and funding liquidity risks of banks, which have been main drivers of the recent financial crisis. The model takes into account the first and second round (feedback) effects of shocks, induced by behavioural reactions of heterogeneous banks, and idiosyncratic reputation effects. The impact on liquidity risk is simulated by a Monte Carlo approach. This generates distributions of liquidity buffers for each scenario round, including the probability of a liquidity shortfall. An application to Dutch banks illustrates that the second round effects have more impact than the first round effects and hit all types of banks, indicative of systemic risk. This lends support policy initiatives to enhance banks’ liquidity buffers and liquidity risk management, which could also contribute to prevent financial stability risks. Key words: banking, financial stability, stress-tests, liquidity risk JEL Codes: C15, E44, G21, G32