Liquidity Risk Macro Stress-testing of the Banking System

In order to analyze the impact of financial asset price shocks on the banking system, this paper develops a macro stress-testing framework to assess liquidity risk, credit risk and market risk. Firstly, using the Monte Carlo method to simulate market. risk path generated by the financial asset price shocks; secondly, using Morton model to analyze the linkage between market and default risks of banks, while the linkage between default risk and deposit outflows is estimated econometrically; Contagion risk is also incorporated through banks' linkage in the interbank and capital markets. Finally, the framework is applied to a group of banks in China, based on publicly available data as at the end of 2008. Its test results show that: the liquidity risk of the bank system is very low, the probability of no bank default is 99.15%, and the entire bank system is stable.