An analysis of stress testing techniques used by bank of Uganda

Abstract

Uganda’s central bank – Bank of Uganda – is mandated with ensuring that the banking system remains in a healthy state so as to ensure that the economy runs smoothly and efficiently so as to foster economic growth and development. Stress tests form a crucial part of the repertoire used by banking sector regulators and supervisors – such as Bank of Uganda – use to assess the resilience of banks to macroeconomic shocks. Such shocks include factors that might affect loan performance such as fluctuations in the exchange rate, changes in oil prices and variations in the interest rate. Stress tests attempt to establish how resilient bank portfolios are by simulating shocks. It is the purpose of this dissertation to briefly analyze stress testing as carried out by Bank of Uganda. The economic concept of scarcity implies that governments and corporate institutions and households will not always have adequate funds to achieve their different objectives. Such objectives may include investment in infrastructural development by governments, and business expansion by businesses. While the financial system — through financial institutions — makes it possible to channel much needed funds from surplus units to deficit units within the broader macro economy, effective financial intermediation is constantly faced with various risks. As evidenced by the 2008 banking crisis, commercial banks are at the risk of losing large amounts of assets and becoming insolvent if risk is not properly assessed.