Market and funding liquidity stress testing of the Luxembourg banking sector

In general, banks’ business lines and, therefore their buffers’ composition, determine the net effect of the shocks on banks’ stochastic liquidity buffers. So, results differ across banks. Second-round effects exemplify the relevance of contagion effects that reduce the systemic benefits of diversification. While systemic liquidity risk is low following a shock to the interbank market, for Luxembourg, with its high number of subsidiaries of large foreign financial institutions, the results indicate the importance of monitoring the liquidity of parent groups to which Luxembourg institutions belong. In particular, shocks to related-party deposits are important. Finally, the results, including those of a run-on-deposits shock, show the relevance of system-wide measures to minimize the systemic effects of liquidity crises.

JEL Classification Numbers: E5, C1, G2

Keywords: stress test, liquidity risk, banks, stochastic, contagion, macro-prudential