Learnings around Stress Testing
• Expanded Stress Testing activities are good for the business
(i.e., good risk management), and a necessary component of
an Internal Capital Adequacy Process (ICAP).
• Coordinated bank-wide stress tests need to have a consistent
starting point (or kickoff) – the agreed upon scenario (e.g., the
forecasted macro economic indicators).
• Stress Testing is a repeatable process, not a one-time project –
there needs to be a dedicated team with clear roles &
responsibilities (cutting across Treasury/Finance, Risk
Management, the LOBs, etc).
• Stress Testing needs to connect directly into Capital Planning,
Profit Planning, and Strategic Planning.
• There needs to be a focus on continuous improvement…
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Replies
Hi Michael,
How about RSQ as a driver of risk ?
Michael Wein said:
Stress Test Notes from the presentation of a SVP at a large US Bank
Common challenges in the industry in developing
enterprise-wide stress tests
Maintaining deep historical data, with good data quality.
• Drilling down to the “right” level of granularity of the models.
• Having well-defined Stress Testing documentation, which
revolves around the:
– Data used.
– Assumptions made.
– Models chosen.
– Calculations.
– Scenario(s) defined (e.g., economic conditions).
• Understanding inter-risk correlations (is there diversification
or a magnification effect?).
• Strong Model Governance.
Learnings around Stress Testing (cont’d)
• You need to continually strive for the right balance of
quantitative analysis (e.g., modeling) and qualitative analysis
(e.g., expert/fundamental credit analysis).
• A risk management culture is enhanced with the development
of a well-defined risk appetite and a set of risk tolerances.
This brings even more meaning to activities such as stress
testing (e.g., how far out of tolerance will my stress take me?).
• Strong governance (e.g., an ERM Committee & the Board) is
essential.
• Third party perspectives and benchmarking can help enhance
the overall process.
• You should be thinking about stress testing all the time…
…But remember that Stress Scenarios are developed
to be applied across all risk types.
Macro Scenario – Variables
• GDP.
• Unemployment.
• Home Prices.
• Credit spreads.
• Consumer Price Index.
Risks
• Credit, Market, Operational, Liquidity, etc.
For example, for Credit Risk, there are a number of models/methodologies that can be leveraged:
Risk Rating models – mapping macro economic variables to
the drivers of capital for each risk (e.g., in the case of Credit
Risk, the drivers are PD and LGD).
Historical transition matrices.
Economic Capital models (run at various confidence levels).
And the more granular the better (i.e., segmenting by product,
industry, geography, etc.).