1 Stress Testing Stress Tests The Need for the Global Regulation of Supervisory Stress Tests By Matthias Goldmann* Draft, October 2013 A. Introduction .......................................................................................................................1 B. Potential and Risks: Function and Contingency of Stress Tests ..........................................3 I. The Function of Stress Tests: Risk Prevention and Confidence Creation..........................3 1. Internal Stress Tests ....................................................................................................3 2. External or Supervisory Stress Tests ...........................................................................5 II. The Contingency of Stress Tests: Supervisory Discretion ...............................................9 1. Scenario Selection and Definition ...............................................................................9 2. The Model: Applying the Scenario............................................................................ 11 3. Measuring the Result ................................................................................................ 12 4. Intermediate Conclusion: Multiple Contingencies and Supervisory Discretion .......... 13 C. Why Supervisory Stress Tests Require International Regulation ...................................... 13 I. Stress Tests as Exercises of Public Authority ................................................................. 13 1. The Concept of International Public Authority .......................................................... 13 2. Supervisory Stress Tests as Exercises of Public Authority ......................................... 15 3. Supervisory Stress Tests as Exercises of International Public Authority? .................. 17 II. Global Regulation of Stress Tests for Global Financial Stability................................... 18 1. Financial Stability as a Global Public Good .............................................................. 18 2. Stress Test Contingency as a Threat to Global Financial Stability ............................. 19 D. Stress Tests as a New Standard Instrument....................................................................... 21 I. The Vertical Dimension of Standard Instruments for the Exercise of Public Authority ..21 II. Emerging Standards for Supervisory Stress Tests ......................................................... 22 1. Procedures for Scenario Selection and Risk Model Design........................................ 24 2. Timing of Stress Tests............................................................................................... 25 3. Publication of Results ............................................................................................... 25 4. Rules on the Use of Stress Tests ................................................................................ 26 5. Follow-Up Plan......................................................................................................... 26 E. Conclusion ....................................................................................................................... 27 A. Introduction Since the onset of the financial crisis in 2008, financial market supervisors in developed economies 1 have been busy strengthening the resilience of financial institutions within their * Senior Research Fellow, Max Planck Institute for Comparative Public Law and International Law, goldmann@mpil.de . This paper was originally presented at the Global Administrative Law Seminar in Rome in 2012. Thanks to Giulio Napolitano, seminar participants, and Johanna Dickschen for helpful comments.