A macro stress test application on the financial system of Turkey: A credit risk perspective

Macro stress testing applications were initially introduced in 1991 with the Financial Sector Assessment Program (FSAP) launched by International Monetary Fund (IMF). Along with each economic and financial crisis, the popularity of macro stress testing increased. This study aims to investigate the financial stability of Turkey by testing it against shocks on macro variables using the Vector Error Correction model and the most up-to-date publicly available data. To this end, the banking sector as the main pillar of the financial sector was stress-tested against macroeconomic shocks using the Vector Error Correction Model based on monthly data for the period between 2005-2021. The impact of the shocks on the selected financial stability indicator, non-performing loan ratio was analyzed using Impulse Response Functions. The results showed that the banking sector was resilient to the applied shocks and the increase in non-performing loan ratio was of no significant concern. The present study also highlighted that the need for prudential oversight by conducting periodic tests and publication of the results remains of substantial importance to be prepared for possible future shocks.