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Stress Testing
This document discusses stress testing frameworks and critical success factors. It covers topics such as stress testing models, scenarios, risk types, aggregation, business impacts, and mitigation plans. The key aspects are robust stress testing models across all material risk types, senior management buy-in and use of insights to address issues, and embedding stress testing into the decision-making process consistently across the organization. Data reconciliation and clearly defined scenarios are also important factors.
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Stress Testing
- 1. STRESS MANAGEMENT Capital Mitigating P & L Impact RWA Impact Impact Measures Positive Impact Provisions, Interest Trade Divestment, Rate Income, Capital, Fees, etc Commission Impairment Rating Negative Impact Operating & Increased Adm. Costs Increased Net Cost of RWA P&L Funding Impact Trading Loss
- 2. STRESS ASSESSMENT Capital Impact Liabilities & Assets Equity Bank Book Default Assets Restructuring Loans, Debt, Wholesale Macro Scenario Receivables, Retail Securitisation Inter Bank Interest Rate Scenario Trade Book Sovereign Haircut Real Estate Equity Market Risk Scenario
- 3. RISK MANAGEMENT Risk Assessment Capital Risk Appetite ICAAP Economic Capital Counterparty Operating Environment Customer / Market / Credit / Operations / Regulatory / Insurance Risks External Factors Exposure Internal Factors Portfolio Product Scenarios / Sensitivity Policies / Models Valuation, Impairment, etc
- 4. STRESS TESTING MODEL Operational Model Integrated Risk Processes & Appetite Stress Policy Risk Sensitivity & Scenario Definition Business Impact - Environment & Operations Financial Measures Strategic & Operational Parameters Macro Economic Reporting - Impact of Profit & Loss A/C Operating Balance Sheet Conditions Stress Test Capital Engine Liquidity Business & Including Explain Portfolio Factors & Assumptions Impact Business Scenarios Mitigating / Risk Stress Models - Remedial Impact Factors Model Selection Business, Risk, Actions & Calculation Finance, Valuation Criteria Treasury Validation & Reconciled Risk & Finance Data Approval Finance Infrastructure
- 5. STRESS TESTING CRITICALSUCCESS FACTORS Robust and comprehensive models, with appropriate scenarios, vetted and supported by senior stakeholders. Senior Management uses insights derived from stress testing to address problematic business areas. Stress testing must be embedded into the decision-making process in a consistent manner across business units and into valuation models. Reconciled risk, finance and treasury data must be used for stress testing accordingly. Shortfalls in stress testing have led to a lack of credibility and limited buy-in from senior management in critical decision making and/or taking preventative actions based on stress testing results. Risk appetite should be embedded in business units and monitored with stress test results measured against it. Stress results should be applied to test how the firm responds to adverse market conditions in terms of risk sensitivity and risk management effectiveness. Stress testing capabilities should comprise of all risk types applicable, be consistent, aggregate exposures across product lines, businesses and legal entities, and address the secondary effects of risk in capital structure and strategy. A challenge is to define scenarios which are useful both to the business and to the risk management function. Behavioural assumptions must be consistently applied to gauge effects of risk events on market and credit activities. Valuation data and associated risk measures should be consistently applied across all positions, products, operating units, and legal entities. Data elements must be available across all required dimensions, including risk factor hierarchies, trade data, static data, daily valuations, sensitivity data, business entity exposures, VaR, and EaR, etc. Prior methodologies and procedures such as Value at Risk and Economic Capital provide an overall net view of risk making it incomplete, as they disguised the size of individual positions. Exposures were netted and reduced by hedges and further reduced by correlations, hiding the true size of gross exposures. Sensitivity Scenario Business & Mitigation & Plausibility Risk Types Aggregation Financial Factors Generation Contingency Test Impact Plan
- 6. Integrated Stress Testing • Aggregate Level • For Decision Making Top Down • Available On Demand • Quick View of Position and Impact • 80 % Accuracy • Transaction Level • For Reporting Bottom Up • Annual Exercise or Expected Event Based • 100 % Accuracy • All Business and Operating Units Enterprise Wide • All Portfolios Risk Types • Across All Material Risk Types of the Enterprise Embedded In • Core of the Decision Making Level of the Business Business • Into Risk Appetite at Capital and Limit Setting Level
- 7. Stress Testing Framework Directives Policy Initiative Economic Variables Sectoral Decomposition Credit And Materiality Scenarios Severity Counterparty Cross Risk Effects Concentration Decomposition Management Calculation Market Of Integration Material Risks Analysis Operational Test execution Reporting Liquidity Capital Approach Liquidity Funding Operational and Insurance Regulatory Resources Ratings Margins Compliance Capital Planning Insurance Business Planning Stress Contingency Planning Reputation Impacts Mitigation Effectiveness Business Triggers