Macro stress testing in the banking system of China

In this paper, we develop a framework for macro stress testing of China’s banking system. Our estimates of the correlations between banks’ stability indicators and macroeconomic factors establish significant relationships between the nonperforming loan ratio and key macroeconomic variables, such as GDP growth, the retail price index, the unemployment rate, total fixed investment, the money supply, interest rates, and exchange rates. Further, results from the macro stress tests show that robustness, or otherwise, of the banking system is highly dependent on the source of the potential risk. Our value-at-risk tests suggest that (at a 99% confidence level) the Chinese banking system is robust with respect to interest rate shocks. However, GDP growth and exchange rate shocks exhibit a profound negative effect, indicating that significant losses become likely. These results should inform investors, policy makers, and regulators with regard to loss-limitation in China’s banking system.