Stress Testing Frameworks and Practices in Dual Banking System: A Preliminary Assessment

Abstract

This paper critically reviews and evaluates stress-testing frameworks and practices of supervisory authorities in a dual banking system namely Malaysia, Indonesia and Pakistan. The analysis suggests that similar to single banking system, there are two main designs to stress testing -bottom-up and top-down - depending on the institutional responsibilities and computational capabilities, while relying on two main techniques of stress tests, sensitivity tests and scenario tests (historical or hypothetical). None of these countries differentiates the stress testing design and approach between conventional and Islamic banking industry. The application of stress testing in these countries follows similar approach to conventional banking system. The analysis also suggests that stress-testing approach for Islamic banking system should be developed capturing the unique balance sheets structure and risks of Islamic banking so that it provides accurate assessments of vulnerability in the Islamic banking system.