Why stress testing is becoming the strategic backbone of Financial Services

In this environment, stress testing has moved from a regulatory exercise to a core management discipline - central to understanding resilience and informing decision‑making under uncertainty. 

In our previous article we explored how liquidity pressure is often the first visible sign of stress, and why rapid execution, governance and communication now matter as much as stock measures. But liquidity is only one channel through which stress materialises. To understand how firms withstand multiple, overlapping shocks, stress testing must take a broader view - one that captures financial, operational and behavioural responses over time.

Drawing on insights from CROs across banking and insurance, this article explores how stress testing is evolving across Financial Services (FS), how approaches differ by sector, and why firms increasingly use it as a strategic tool rather than a compliance obligation.

Why does stress testing matter now more than ever?

Across the industry, one message is consistent: the pace and shape of stresses have changed. Shocks now transmit more quickly through markets, operations and balance sheets, exposing weaknesses before capital or solvency metrics are breached. As a result, stress testing is no longer about producing loss numbers alone. Its real value lies in revealing how an organisation behaves when assumptions fail.

Well-designed stress tests expose where management actions prove harder to execute than expected. Robust stress tests are designed to identify weaknesses, support financial resilience and strategic planning and improve preparedness by identifying tangible and diversified management actions and informing key recovery plan activities. Operational and behavioural insights often surface before balance‑sheet impacts, making stress testing a powerful early‑warning mechanism. Under‑calibrated scenarios and overly theoretical management actions can create false comfort about speed, feasibility and market access that do not hold in a real stress.

At its most effective, stress testing shifts the focus from what the risks are to how the firm responds when they crystallise - a critical distinction in an environment where resilience depends as much on coordination and agility as on capital strength.

Common stress testing challenges across the sector

Despite increasing regulatory and management attention, firms across FS face persistent challenges in making stress testing meaningful. Industry exercises have repeatedly shown that plans which appear robust on paper can fail under pressure: governance becomes unclear when shocks accelerate, escalation routes break down during operational outages, and cross‑functional dependencies delay response times.

A recurring weakness is the development and treatment of management actions. Many firms still rely on high‑level assumptions rather than explicitly defining when actions would be triggered, how quickly they could be executed, and what their measurable impact would be. In practice, actions that appear credible on paper often rely on functioning markets, clear governance and immediate execution - conditions that quickly deteriorate when stress crystallises. Without explicitly defining triggers, timelines and execution constraints, firms risk overstating the benefit of these actions and underestimating the severity of outcomes. The result is false comfort: resilience that exists in models, but not in reality, with gaps only exposed when the firm is required to act under real pressure. Moreover, firms utilising the same set of management actions across stress scenarios limits the options available to them for the range of severity found in stress. Not all stresses will result in the need for drastic recovery options; firms should identify day-to-day actions, more extreme management actions and separate recovery options. For insurers, this is compounded by regulatory and contractual constraints on repricing, policyholder bonuses and reinsurance. For banks, the feasibility of actions under extreme market or liquidity stress often determines whether recovery options remain credible.

Another challenge is scenario design. Stresses rarely occur in isolation. Rate shocks, market volatility, operational disruption and behavioural responses tend to interact, amplifying impacts across liquidity, solvency, earnings and reputation. Yet many stress testing frameworks still test risks in silos, underestimating the severity of real‑world events, the speed at which vulnerabilities accumulate and, overlooking the speed and intensity with which interdependencies can propagate across the firm. Developing multi-factor scenarios, combining, for example, geopolitical shocks with macroeconomic tightening, or cyber events with third‑party failures enables firms to better capture these linkages and second‑order effects. This more integrated approach provides a more realistic view of how stress unfolds in practice, strengthening preparedness and enhancing financial resilience.

How does stress testing differ for Banks and Insurers?

While banks and insurers both rely on stress testing, their objectives and time horizons differ.

For banks, stress testing focuses on survival under rapid, often liquidity driven shocks. Supervisory exercises are short term, prescriptive and regulator led, prioritising capital and liquidity preservation over profitability. Larger and more complex banks increasingly refresh stress metrics frequently, even daily, to track evolving exposures.

Insurers additionally face slower burn stresses driven by long dated liabilities, claims behaviour and market movements. Their frameworks, anchored in Solvency II and the ORSA, are less prescriptive and more strategic, designed to assess how solvency, liquidity, earnings, risk exposures and policyholder outcomes evolve over multiple years. The emphasis is less on clearing a fixed hurdle and more on shaping underwriting, investment and reinsurance strategy over time.

How insurers can leverage banking practices

Insurers can borrow proven banking disciplines to strengthen resilience:

• Adopt banking disciplines around crisis playbooks and well-defined escalation routes.
• Conduct full fire-drill recovery exercises, simulating end-to-end crisis scenarios and practising the operational decisions that would be required in real life.
• Strengthen the linkage between stress testing outcomes, risk appetite thresholds and governance decisions.

What banks can learn from insurers

Cross sector learning works both ways. Banks can take valuable lessons from insurers’ long term resilience mindset:

• Take a longer‑term view of resilience through multi‑year stress horizons.
• Integrate balance‑sheet dynamics, behavioural responses and management actions into stress scenarios.
• Use stress testing to understand how vulnerabilities evolve over time, not just short‑term survival.

How can firms strengthen their stress testing capability?

Firms who derive the greatest value from stress testing are those that treat it as a continuous management discipline rather than an annual modelling cycle and:

• Invest in horizon scanning, scenario refinement and stronger data foundations to surface vulnerabilities earlier.
• Embed stress testing into decision‑making, using outputs to shape risk appetite, capital planning, reinsurance strategy and investment choices rather than producing standalone reports.
• Focus on execution, not theory. Credible, workable management actions under pressure are what differentiate resilient firms from those that respond reactively. Use fire drills to pressure‑test the organisation end‑to‑end.
• Use stress tests to uncover behavioural and operational gaps, such as broken escalation chains or unclear governance, before they appear in a real stress event.
• Strengthen data governance and operational readiness in line with regulatory expectations around resilience, cyber risk and forward‑looking stress capabilities.