A hybrid stress testing mathematical model for evaluating financial stability in selected commercial banks in Uganda

Abstract

This study is on the multidimensional risks a ecting commercial banks in Uganda through the development of a hybrid stress testing model that integrates market, credit, liquid- ity, systemic, and climate-related risks. The study enhances nancial system resilience by capturing both idiosyncratic and systemic vulnerabilities through simulation-based methodologies tailored to the Ugandan context. The study focuses on eleven commercial banks in Uganda that were selected based on pro tability as at the end of 2023. The study approach combines agent-based modeling, Monte Carlo simulations, and scenario analysis to evaluate the impact of extreme but plausible macro- nancial shocks. The Climate Extended Risk Model (CERM) was im- plemented to project climate-induced GDP losses using historical trends and stochastic climate parameters. Systemic risk was modeled through interbank exposure networks and covariance-based metrics to simulate contagion and failure cascades. Market and credit risks were assessed using Value-at-Risk (VaR), CoVaR and ∆CoVaR, applied to Uganda-speci c macroeconomic indicators. Results show that severe physical climate risk scenarios could cause cumulative GDP losses of approximately UGX 1.87 trillion (≈ USD 492 million) over 25 years. Credit losses tied to agricultural lending are projected to reach UGX 21.43 billion (≈ USD 5.6 million). Simulated contagion revealed an average of 3.54 bank failures per shock, corresponding to expected losses of UGX 565.70 billion (≈ USD 150 million). Liquidity and capital bu ers of less pro table commercial banks were found to be more vulnerable to cascading defaults; with a total liquidity loss of UGX 138.55 billion (≈ USD 36.46 million). Total CoVaR estimates indicate potential losses of UGX 115.15 billion (≈ USD 31 million) for credit risk and UGX 91.82 billion (≈ USD 25 million) for market risk, primarily driven by exchange rate volatility (exchange rate is assumed to be UGX 3800 per USD). The ndings underscore the urgent need for policymakers and regulators to strengthen macroprudential policies, enhance climate- nancial risk disclosure, and promote sectoral diversi cation in lending portfolios. It is recommended that the Bank of Uganda adopt hybrid stress testing models in supervisory practices and expand data collection for gran- ular sectoral exposures. Targeted capital and liquidity requirements for vulnerable com- mercial banks, coupled with coordinated climate adaptation policies, will be critical for safeguarding nancial stability in Uganda