Forecasting is essential in the banking industry as it helps the banks foresee some of the risks they might end up encumbered with if current trends persist. Stress tests are commonly used by banks to predict if they are capable of maintaining adequate amounts of capital even when the economy is under precarious circumstances.
Macro factors are often used as variables to forecast the behaviors and performance of banks under stressful conditions. The macro variables usually improve the forecasts on capital measures, revenues, and charge-off on loans. The macro-variables considered usually include the national house price index and its growth rate, the unemployment rate, the real GDP growth, the real interest rate, and the term spread.
The national house price index and its growth rate is used as a variable to measure bank performance because a falling index will result in increased default rates for the banks. A rising or stable growth rate will mean that the people with loans are less likely to default on their loans. This is because the higher the house prices, the less likely a customer would default on his mortgage. Banks perform better with a high national house price index than with a lower or declining growth rate.
Real interest rate is also an important variable in measuring bank performance especially when conducting stress tests. The rise in interest rates indicates that the economy is strong, which paints a positive picture for the banks. A high interest rate reduces the risk that borrowers will default and this increases the value of the bank’s assets. The bank assets are more liquid with high interest rates, and the credit demand continue to rise increasing a bank’s lending business.
The GDP refers to the value of all the finished goods and services that a country produces within a specific time. A higher GDP indicates that the economy is performing extremely well. A decreasing GDP translates to a poorly performing economy. The GDP trends in the country will affect the demand for bank assets. A higher GDP will increase the demand for bank assets while a lower GDP decreases the demand for the bank assets.