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…

 

_____________________________________________________________________________________________________________________

Editorial additions. Best practices, case studies and white papers.

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Replies

  • Hi Michael,

     

    How about RSQ as a driver of risk ?


    Michael Wein said:

    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.).

  • 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.).

This reply was deleted.

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