Stress Testing
Adopt best pratices to augment credit risk management capabilities
Overview
Stress test forms an integral part of the overall governance and risk management culture of a bank. Stress testing should be dynamic, responding to the situation and should be helpful to the senior management and board members in making decisions related to capital, businesses etc.
Stress Testing is an important risk management tool that is used by banks as a part of their internal risk management. Stress testing is a tool that supplements Liquidity Risk management tools. It informs management about the adverse situations and help them to make informed decision about the capital plan needed to absorb such losses.
Stress testing is also a major focus area of the regulators as they conducted regular stress tests based on pre-defined economic scenarios to understand the resilience of individual banks and banking system as a whole. It is promoted by supervisors through Basel Capital Adequacy framework. Basel requires banks to have in place rigorous programme of stress testing for major types of the risks viz. market, Credit, Operational and Liquidity. According to Basel; stress testing should form an integral part of the Pillar II ICAAP, it should be forward looking and should take into account the possible events or changes in the market conditions that could adversely affect the bank.
Stress testing is also integral to IFRS 9 requirements, as it requires forward-looking estimates for the risk components used for ECL calculations.
Offerings
- We help our clients in performing stress test that cover range of risks and business lines to give a firm-wide integrated picture in the event of stressed conditions.
- The framework defines the purpose of the stress testing, most material business areas and events that might significantly damage the firm. A range of measures are used to convey the impact such as economic capital, asset values, liquidity and funding gaps etc.
- Our stress testing approach helps the firm to assess the effectiveness of risk mitigation techniques used, as in the time of stress when markets are not functioning properly and every other firm is using similar risk mitigation techniques, the firm does not run into trouble.
- Define the governance structure and contingency action plan.
- Define the roles & responsibilities to effectively manage the firm wide stress testing framework.
- Define the types of stress tests to be conducted and at what frequency.
- Defining the methodology to develop scenarios for stress testing.
- Define the role of expert judgement and the purpose of each component of the stress testing.
- Establishing the appropriate timeline and frequency and method of communication of feedbacks.
- Identifying the range of remedial actions performed on the basis of purpose and result of stress testing, and the feasibility of the remedial actions.
- Our framework allows our clients to understand the impact of stressed conditions by conducting sensitivity based stress tests (where key factors are stressed to understand their impact on standalone basis), scenario based stress tests (integrated stress tests which take into consideration interplay of different risk factors in a given macroeconomic condition) and reverse stress testing.
- It considers interrelationships between various factors such as price shocks, market shocks, macroeconomic shocks, diminished access to secured or unsecured funding etc.
- We support our clients in meeting the annual stress testing requirements based on regulator defined macroeconomic scenarios, which are uniformly applied across the banking sector.
- We extensively help our clients to build macroeconomic models and linking the same to the default behaviour of the client’s portfolio.
