Indeed, in practice, banks often model the effect of even severe macroeconomic shocks as if they were occurring to the bank in isolation. They thus may assume that they have freedom to readjust their balance sheets and lending practices in the event of an adverse shock, without considering whether other banks may be trying to do the same thing and the effect that these behavioural responses may have cumulatively on market liquidity and on the economy as a whole. An important implication is that many firm-level stress tests may consequently underestimate the possible impact of adverse shocks. As I have highlighted, some of the potentially missing effects should be captured in the proposed suite of models. But the proposed enhanced “top-down” approach outlined above may still benefit from additional insights gained from closer dialogue and interaction with major financial firms on their likely reaction to episodes of stress. I consequently think there is merit in more formal comparison of “top-down” and “bottom-up” stress testing exercises, and of seeking ways of integrating the two into more formal “systemic” stress tests, where the authorities present an initial scenario to firms and then modify the scenario in the light of feedback on the potential response by firms in an iterative loop. This approach has recently been pioneered by the Dutch central bank.
Second principle: The criteria governing the management of foreign exchange reserves are primarily the security of investments and their liquidity. Return is also a factor. Secure and liquid assets are key, because the SNB must always be able to implement its monetary policy, and hence must have rapid access to its foreign exchange reserves, should the need arise. The need for secure assets means that a large proportion of our investments are in government bonds; the need for liquidity means that we invest in the world’s most liquid assets and currencies. Finally, the third principle is this: The SNB takes care to ensure that its investments do not disrupt the markets. We are aware that the huge amounts we have under management could impact significantly on market prices. To prevent this kind of problem, we control the volumes we place on the markets, so as to avoid having any perceptible market impact. Thus, with such a large volume to invest, there is a fairly long period of transition before the desired allocation is achieved. We are sometimes obliged to hold liquidity on our accounts at other central banks for a while, until it can be invested in line with our investment strategy. A number of players are involved in implementing the investment strategy. I am not planning to go into too much detail about the investment process today. Briefly, the Governing Board decides on the main investment principles, as well as the strategy.