Stress Test

A stress test is a simulation or analysis conducted by financial institutions to evaluate how a portfolio, investment, or company will perform under adverse economic or market conditions. Stress tests help assess risks and vulnerabilities, ensuring that the institution has enough capital to withstand financial shocks. They are commonly used by regulators to evaluate the resilience of banks and financial institutions.

Example

A bank conducts a stress test by modeling how its loan portfolio would be affected by a significant economic downturn, such as a recession or market crash, to ensure it can maintain solvency.