A "How To" Guide for Stress Testing the ERM Way


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For more about stress testing, go to http://www.moodysanalytics.com/Stthatfits

» Stress Testing Pre and Post Crisis:
– Stress Tests as Early Warning Devices
– The Regulatory Response
– Lessons Learned
» Key Elements of an Integrated Stress Testing Framework:
– Scenarios
– Data
– Models
– Deployment Platform
» How we can help RiskMatrix 2

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  • Caters for future needs – common to all Moody’s ERM solutions – fully integrated.
  • A "How To" Guide for Stress Testing the ERM Way

    1. 1. RiskMatrixA “how to” guide for Stress Testing theERM wayDubai IT Conference Ioannis Stamatopoulos November 2012
    2. 2. Agenda» Stress Testing Pre & Post Crisis: – Stress tests as early warning devices – The Regulatory response – lessons learnt» Key Elements of an integrated Stress Testing Framework: – Scenarios – Data – Models – Deployment Platform» How we can help RiskMatrix 2
    3. 3. 1 Stress Testing Pre and Post Crisis RiskMatrix 3
    4. 4. 4Stress Tests as early warning devices “The banking system’s reported financial indicators are above minimum regulatory requirements and stress tests suggest that the system is resilient. IMF, Iceland: Financial Stability Assessment – update, 19 August 2008”.» Within two months, Iceland’s three biggest lenders had collapsed, leaving its economy in tatters RiskMatrix 4
    5. 5. 5Regulators to the rescue RiskMatrix 5
    6. 6. 6Stress Testing: Lessons learntDefinition :A stress test is commonly described as the evaluation of the financial position of a bank under a severe but plausible scenario to assist in decision making within the bankThe financial crisis has highlighted weaknesses in current stress testing practices.» Use of stress testing and integration in risk governance» Stress testing methodologies» Scenario selection» Stress testing of specific risks and productsSource: BIS, Principles for sound stress testing practices and supervision, 2009 RiskMatrix 6
    7. 7. Stress Testing – In a nutshell Senior Management Engagement RiskMatrix 7
    8. 8. 2 Key elements of an integrated Stress Testing Solution RiskMatrix 8
    9. 9. Stress Testing Programs require a range of scenarios and severities … Event-Driven Alternative Economic Scenarios Sovereign Emerging In line with Default Markets Regulatory Shock Hard Landing Guidelines Baseline: Recession S4: S3: S2: S1: Severe Double Mild Stronger Double Dip Dip Double Dip Recovery 1-in-25 1-in-10 1-in-4 1-in-4 1:100 1:25 1:20 1:10 1:4 Forecast 1:4 Weaker HealthierEconomy Economy Simulation-Based RiskMatrix 9
    10. 10. 10…accurate forecasts on the impact ofthese scenarios on the Macro Economy… Oil Prices under different alternative scenarios 180 160 Baseline Scenario Stronger Near-Term Rebound Scenario 140 Mild Second Recession Scenario Deeper Second Recession Scenario 120 Protracted Slump Scenario Below-trend Long-term Growth Scenario 100 Oil Price Increase, Dollar Crash, Inflation Scenario 80 60 40 20 0 1996Q2 1997Q1 1997Q4 2001Q3 2003Q4 2004Q3 2008Q2 2009Q1 2009Q4 2013Q3 2015Q4 1994Q1 1994Q4 1995Q3 1998Q3 1999Q2 2000Q1 2000Q4 2002Q2 2003Q1 2005Q2 2006Q1 2006Q4 2007Q3 2010Q3 2011Q2 2012Q1 2012Q4 2014Q2 2015Q1 RiskMatrix 10
    11. 11. … models to translate these scenarios intothe key risk drivers… Performance data » Delinquency Rates and/or CDRs » Prepayment rate and/or CPRs » Net Charge-off Rate Output vectors » Severity of Losses » Prepayments (CPR) » Default (CDR) Econometric » Severity (LGD) model » All under alternative scenarios Macroeconomic vectors » Unemployment Rate, (Un)Employment Growth » Average / Index House Prices » Government interest rate and 10yrs bond rate » Retail Sales Index » Real GDP, Disposable Income, Private Consumption » Total Debt Service Ratio RiskMatrix 11
    12. 12. … all integrated under the same roof Data - Analysis Tools - Scenario Management - User Workflow Economic/Regulatory scenarios Business strategy (MEDC, internal bank scenarios, FED) (growth, risk appetite, target rating, M&A) Translation engines Translation engines Translation engines Translation engines PD & LGD models Market data Balance sheet Costs / Taxes C&I Interest rates Contractual / Behavioral Modeling Commercial RE Market prices Amortizing / New volume Allocation SME Exchange rates Cost of funds Retail Correlations Net interest income Liquidity ratios P&L forecasts Performance indicators Bank’s target rating • Liquidity coverage • Net interest income • RAR / EVA • Global bank scorecard • Net stable funding ratio • Costs • RARORWA • Credit losses • RAROC Bank’s eligible capital Regulatory capital • Common equity • EAD (Behaviors / New volumes) Economic capital • Dividends / Retained earnings • Risk mitigation / Effective LGD • EAD (Behaviors / New volumes) • Minority interests • RWA (EAD, PD, LGD) • Risk mitigation / Effective LGD • Sub debt maturing / Issuance • Countercyclical capital buffer • EC (EAD, PD, LGD, Correlations) • Provisions / EL / Deductions RiskMatrix 12
    13. 13. How we can help An integrated and open stress testing solution that goes well beyond software, leveraging on our economic expertise, financial and economic data repository and modeling services RiskMatrix 13
    14. 14. 14© 2013 Moody’s Analytics, Inc. and/or its licensors and affiliates (collectively, “MOODY’S”). All rights reserved. ALL INFORMATION CONTAINED HEREIN IS PROTECTED BYCOPYRIGHT LAW AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHERTRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR INPART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT MOODY’S PRIOR WRITTEN CONSENT. All information contained hereinis obtained by MOODY’S from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, allinformation contained herein is provided “AS IS” without warranty of any kind. Under no circumstances shall MOODY’S have any liability to any person or entity for (a) any loss ordamage in whole or in part caused by, resulting from, or relating to, any error (negligent or otherwise) or other circumstance or contingency within or outside the control of MOODY’Sor any of its directors, officers, employees or agents in connection with the procurement, collection, compilation, analysis, interpretation, communication, publication or delivery of anysuch information, or (b) any direct, indirect, special, consequential, compensatory or incidental damages whatsoever (including without limitation, lost profits), even if MOODY’S isadvised in advance of the possibility of such damages, resulting from the use of or inability to use, any such information. The ratings, financial reporting analysis, projections, andother observations, if any, constituting part of the information contained herein are, and must be construed solely as, statements of opinion and not statements of fact orrecommendations to purchase, sell or hold any securities. NO WARRANTY, EXPRESS OR IMPLIED, AS TO THEACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION ORINFORMATION IS GIVEN OR MADE BY MOODY’S IN ANY FORM OR MANNER WHATSOEVER. Each rating or other opinion must be weighed solely as one factor in anyinvestment decision made by or on behalf of any user of the information contained herein, and each such user must accordingly make its own study and evaluation of each securityand of each issuer and guarantor of, and each provider of credit support for, each security that it may consider purchasing, holding, or selling. RiskMatrix 14