Definition of stress tests

These are attempts to gauge the health of banks by running disaster scenarios and seeing if they survive. [1]

Ever since banks collapsed – many of them due to a lack of liquidity, regulators have been running regular six-monthly tests on their big banks. The irony is that they focus not on liquidity stress but on capital stress. In other words, whether a bank is solvent rather than whether it has financing to operate day to day.

Example
In 2010, with banks across the continent among the biggest owners of sovereign debt, the idea was to launch a transparent stress-test exercise on 91 of the biggest banks.

The Spaniards were very keen on this idea, because many of their banks, particularly the public-sector cajas, or savings banks, had overstretched themselves with big property lending, which had gone bad as the Spanish property market collapsed. The rumours about sovereign debt problems threatened to break them.

Just as a scarcity of liquid funding in the markets killed Lehman Brothers and other banks round the world, so a similar threat hung over Spain. Lately many banks have only been able to finance their operations via emergency facilities at the European Central Bank. It had a tough job persuading the rest of Europe, Germany in particular, to make the tests pan-European. 

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Interactive graphic: EU stress tests by bank
Interactive graphic: EU stress tests explained
Q&A: How EU stress tests on banks will work

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