Working Paper Series
A Top-down Approach to
Stress-testing Banks
Forthcoming in the Journal of Financial Services Research
Pavel S. Kapinos
Federal Deposit Insurance Corporation
Oscar A. Mitnik
Federal Deposit Insurance Corporation
First Version: December 2013
Current Version: March 2015
FDIC CFR WP 2015-02
fdic.gov/cfr
NOTE: Staff working papers are preliminary materials circulated to stimulate discussion and critical
comment. The analysis, conclusions, and opinions set forth here are those of the author(s) alone and do
not necessarily reflect the views of the Federal Deposit Insurance Corporation. References in publications
to this paper (other than acknowledgment) should be cleared with the author(s) to protect the tentative
character of these papers.
A Top-down Approach to
Stress-testing Banks
Forthcoming in the Journal of Financial Services Research
Pavel S. Kapinos
Federal Deposit Insurance Corporation
Oscar A. Mitnik
Federal Deposit Insurance Corporation
First Version: December 2013
Current Version: March 2015
FDIC CFR WP 2015-02
fdic.gov/cfr
NOTE: Staff working papers are preliminary materials circulated to stimulate discussion and critical
comment. The analysis, conclusions, and opinions set forth here are those of the author(s) alone and do
not necessarily reflect the views of the Federal Deposit Insurance Corporation. References in publications
to this paper (other than acknowledgment) should be cleared with the author(s) to protect the tentative
character of these papers.
A Top-Down Approach to Stress-testing Banks ∗
Pavel Kapinos†
Federal Deposit Insurance Corporation
Oscar A. Mitnik
Inter-American Development Bank
March 17, 2015
Abstract
We propose a simple, parsimonious, and easily implementable method for stress-testing banks
using a top-down approach that evaluates the impact of shocks to macroeconomic variables
on banks’ capitalization. Our method relies on a variable selection method to identify the
macroeconomic drivers of banking variables combined with a principal component analysis. We
show how it can be used to make projections, conditional on exogenous paths of macroeconomic
variables. We also rely on this approach to identify the balance sheet and income statement
factors that are key in explaining bank heterogeneity in response to macroeconomic shocks. We
apply our method, using alternative estimation strategies and assumptions, to the 2013 and
2014 stress tests of medium- and large-size U.S. banks mandated by the Dodd-Frank Act, and
obtain stress projections for capitalization measures at the bank-by-bank and industry-wide
levels. Our results suggest that while capitalization of the U.S. banking industry has improved
in recent years, under reasonable assumptions regarding growth in assets and loans, the stress
scenarios can imply sizable deterioration in banks’ capital positions.
JEL Classification: G17, G21, G28.
Keywords: stress testing, banking, Dodd-Frank Act.
∗Previous versions of the paper were circulated under the title “Can Top-Down Banking Stress Test be Informa-
tive?” We have benefited from comments and suggestions from Rosalind Bennett, Steve Burton, Gary Fissel, Mark
Flannery, Mark Flood, Levent Guntay, Vivian Hwa, Kyung-So Im, Stefan Jacewitz, Myron Kwast, Emily Johnston
Ross, Benjamin Kay, Troy Kravitz, Paul Kupiec, John O’Keefe, Jon Pogach, Carlos Ramirez, Jack Reidhill, Sarah
Riley, Til Schuermann, Haluk Unal, Chiwon Yom, and seminar participants at the FDIC, the 2013 Southern Eco-
nomic Association Annual Meeting, the 2014 Annual AEA Meeting in Philadelphia, the Conference on Enhancing
Prudential Standards on Financial Regulation at the Philadelphia Federal Reserve, and the Treasury’s Office of Fi-
nancial Research. Cody Hyman and Arthur J. Micheli provided excellent research assistance. The opinions expressed
in this publication are those of the authors and do not necessarily reflect the views of the Federal Deposit Insurance
Corporation or the Inter-American Development Bank, its Board of Directors, or the countries they represent. Mitnik
completed work on this project while employed by the Federal Deposit Insurance Corporation.
†Corresponding author. E-mail: pkapinos@fdic.gov. Phone: (202) 898-6587. Address: Division of Insurance and
Research, Federal Deposit Insurance Corporation, 550 17th Street NW, Washington, DC 20429.
Pavel Kapinos†
Federal Deposit Insurance Corporation
Oscar A. Mitnik
Inter-American Development Bank
March 17, 2015
Abstract
We propose a simple, parsimonious, and easily implementable method for stress-testing banks
using a top-down approach that evaluates the impact of shocks to macroeconomic variables
on banks’ capitalization. Our method relies on a variable selection method to identify the
macroeconomic drivers of banking variables combined with a principal component analysis. We
show how it can be used to make projections, conditional on exogenous paths of macroeconomic
variables. We also rely on this approach to identify the balance sheet and income statement
factors that are key in explaining bank heterogeneity in response to macroeconomic shocks. We
apply our method, using alternative estimation strategies and assumptions, to the 2013 and
2014 stress tests of medium- and large-size U.S. banks mandated by the Dodd-Frank Act, and
obtain stress projections for capitalization measures at the bank-by-bank and industry-wide
levels. Our results suggest that while capitalization of the U.S. banking industry has improved
in recent years, under reasonable assumptions regarding growth in assets and loans, the stress
scenarios can imply sizable deterioration in banks’ capital positions.
JEL Classification: G17, G21, G28.
Keywords: stress testing, banking, Dodd-Frank Act.
∗Previous versions of the paper were circulated under the title “Can Top-Down Banking Stress Test be Informa-
tive?” We have benefited from comments and suggestions from Rosalind Bennett, Steve Burton, Gary Fissel, Mark
Flannery, Mark Flood, Levent Guntay, Vivian Hwa, Kyung-So Im, Stefan Jacewitz, Myron Kwast, Emily Johnston
Ross, Benjamin Kay, Troy Kravitz, Paul Kupiec, John O’Keefe, Jon Pogach, Carlos Ramirez, Jack Reidhill, Sarah
Riley, Til Schuermann, Haluk Unal, Chiwon Yom, and seminar participants at the FDIC, the 2013 Southern Eco-
nomic Association Annual Meeting, the 2014 Annual AEA Meeting in Philadelphia, the Conference on Enhancing
Prudential Standards on Financial Regulation at the Philadelphia Federal Reserve, and the Treasury’s Office of Fi-
nancial Research. Cody Hyman and Arthur J. Micheli provided excellent research assistance. The opinions expressed
in this publication are those of the authors and do not necessarily reflect the views of the Federal Deposit Insurance
Corporation or the Inter-American Development Bank, its Board of Directors, or the countries they represent. Mitnik
completed work on this project while employed by the Federal Deposit Insurance Corporation.
†Corresponding author. E-mail: pkapinos@fdic.gov. Phone: (202) 898-6587. Address: Division of Insurance and
Research, Federal Deposit Insurance Corporation, 550 17th Street NW, Washington, DC 20429.