Reverse stress test
Sensitivity analysis and stress testing.
A stress test that requires assessment of scenarios and circumstances that would render a business unviable, thereby identifying potential business vulnerabilities.
Reverse stress-testing starts from an outcome of business failure, and identifies circumstances where this might occur.
This is different to general stress and scenario testing, which tests for outcomes arising from changes in circumstances.
- Characteristics of reverse stress testing
- "Reverse stress test means [a financial] institution stress test that starts from the identification of the pre-defined outcome, eg points at which an institution business model becomes unviable, or at which the institution can be considered as failing or likely to fail... and then explores scenarios and circumstances that might cause this to occur.
- Reverse stress testing should have one or more of the following characteristics:
- (i) It is used as a risk management tool aimed at increasing the institution’s awareness of its vulnerabilities by means of the institution explicitly identifying and assessing the scenarios (or a combination of scenarios) that result in a pre-defined outcome.
- (ii) The institution decides on the kind and timing (triggering events) of management or other actions necessary for both (a) rectifying business failures or other problems; and (b) aligning its risk appetite with the actual risks revealed by the reverse stress testing.
- (iii) Specific reverse stress testing can be also applied in the context of recovery planning (eg reverse stress tests applied in a wider context can be used to inform a recovery plan stress test by identifying the conditions under which the recovery might need to be planned)."
- European Banking Authority - Guidelines on institutions' stress testing, July 2018, p14.