1. Monthly Business Review, Volume: 02, Issue: 05, May 2010
Moderate
Minor Major
Shock Level
Stress Testing
Mutual Trust Bank Ltd.

2. Article of the Month
As a starting point the scope of the stress test is limited to
STRESS TESTING simple sensitivity analysis. Five different risk factors have been
To ensure the sustainable development of a financial institution identified and used for the risk factors-
and subsequently the entire Financial System, it is imperative Interest rate
to monitor, measure and control various types of risks. Forced sale value of collateral
Financial institutions around the world have developed a
Non-performing loans (NPLs)
number of quantitative techniques for assessing potential risks.
But the current risk management system based on ordinary Stock prices
business conditions and historical trends is not adequate to Foreign exchange rate
cope with the disorders and extreme market movements e.g.
the 1997-98 Asian financial crisis. The recent 2007-2010 Moreover, the liquidity position of the institution is also stressed
global financial crisis, triggered by a liquidity crisis in the United separately.
States banking system has enhanced the importance of
establishing more developed risk management system for Stress test shall be carried out assuming three different
better understanding and assessing the potential vulnerabilities hypothetical scenarios-
in the financial sectors. Stress testing is one of such
Minor Level Shocks
sophisticated techniques that is increasingly being employed
around the world to determine the reactions of a financial Moderate Level Shocks
institution under a set of exceptional but plausible assumptions Major Level Shocks
through a series of battery of tests. Stress Testing Technique
provides a way to quantify the impact of changes in a number The stress test at simple sensitivity analysis stage is only a
of risk factors on the assets and liabilities portfolio of a single factor sensitivity analysis. Each of the five risk factors is
particular institution. given shocks of three different levels.
In order to further strengthen the country’s financial system, For example, to assess foreign exchange risk, the overall net
Bangladesh Bank has also designed a stress testing open position of the bank/FI including the on-balance sheet and
framework for banks and FIs to proactively manage risks. off-balance sheet exposures shall be charged by the weightage
Bangladesh Bank’s guideline will ensure uniformity and of 5%, 10% and 15% for minor, moderate and major levels
consistency for all the banks and FIs and also conform to the respectively. The impact of the respective shocks will have to be
suggestion of IMF and Basel Committee on banking calibrated in terms of the CAR. The tax-adjusted loss if any
supervision for conducting stress tests. This model guideline arising from the shocked position will be adjusted from the
initially focuses on “Simple Sensitivity and Scenario Analysis”. capital. The revised CAR will then be calculated after adjusting
But with the increasing know-how and availability of more data, total loss from the risk-weighted assets of the bank/FI.
this model is supposed to undergo further refinement over
time. However, one of the limitations of this stress testing technique
is that stress tests do not account for the probability of
At the system level, stress tests are primarily designed to occurrence of these exceptional events. For this purpose, other
quantify the impact of possible changes in economic techniques, for example VaR (value at risks) models etc, are
environment on the financial system. The system level stress used to supplement the stress tests. These tests help in
tests also complement the institutional level stress testing by managing risk within a financial institution to ensure optimum
providing information about the sensitivity of the overall allocation of capital across its risk profile.
financial system to a number of risk factors. These tests help
the regulators to identify structural vulnerabilities and the All banks and Financial Institutions are expected to carry out
overall risk exposure that could cause disruption of financial the Stress Tests on half yearly basis i.e. on June 30 and
markets. Its prominence is on potential externalities and market December 31 on each year with their first stress testing
failures. exercise to be based on the half year ending June 30, 2010 as
per the Bangladesh Bank guidelines and results shall be
There are three techniques for Stress Testing- submitted to the Department of Off-site Supervision (for Banks)
and Department of Financial Institutions and Markets (for
Simple Sensitivity Analysis (single factor tests) Financial Institutions) of Bangladesh Bank within 45 days of the
Scenario Analysis close of each half year in the format proposed by the
Extreme value/maximum shock scenario Bangladesh Bank.
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