Regional Training on Micro Prudential Stress Testing · 2017-09-09 · • A means of identifying and quantifying the inter relationship between risks (e.g. market, liquidity and

Regional Training on Micro Prudential Stress Testing

METACBeirut, Lebanon 20th – 24th Feb 2017

Day 1, Session 4

Typical Stages in Stress Testing

Michael Lau, consultant LA

Stages in the stress testing process …

2

For the purpose of illustration the stress testing process is broken into nine stages

Apply Shocks

Start Date Data

Historical Data

Start Date Data

Historical DataStudy

Measure

Shock

Shocked Output

Re-Study

Re-Measure

11 22 33 44 55 66 77

PerimeterMetrics, Type, etc

Risk, Macro economic, Financial

etc

GatherDesign

Scenarios

Create

88 99

Define

Purpose

ActConclude

Defining the purpose…

3

Apply Shocks

Start Date Data

Historical Data

Start Date Data


Measure

Shock

Shocked Output

Re-Study

Re-Measure

11 22 33 44 55 66 77



etc

GatherDesign

Scenarios

Create

88 99

Define

Purpose

ActConclude

Determine the purpose (regulator) …

• An aid in identifying, assessing and quantifying potential vulnerabilities at a system level and a bank level (ie an early warning device)

• A means to test effectiveness of existing or proposed regulations

• A means of restoring market confidence

• A means of identifying and quantifying the inter relationship between risks (e.g. market, liquidity and credit risk)

• A means of identifying and quantifying interdependencies between financial market participants

• Engagement and communication internally and with banks

• Data integrity checking

• A capability development tool for staff (assists generally in understanding key drivers of bank performance)

• A means of cross checking bank stress testing processes and outcomes

• Contingency planning

• Crisis management (resolution and recovery planning)

Determine the purpose (bank) …

• Meet regulatory risk management requirements (obligatory)

• Meet internal risk management requirements (a developing area)

• Strengthen corporate governance and risk management culture

• Data integrity checking

• Strategic planning

• Capital and liquidity planning

• Contingency and business continuity planning

• Crisis management

• What-if analysis (testing both positive and negative factors)

• Engagement and communication internally and externally

• Business forecasting and planning (entity level or business unit level)

• Training (e.g. risk management, financial management, business planning)

• Validation (reasonableness check of other risk estimation tools)

• Product or business evaluation and competitor analysis

• Risk appetite assessment and limits

The Design Stage…

Apply Shocks

Start Date Data

Historical Data

Start Date Data


Measure

Shock

Shocked Output

Re-Study

Re-Measure

11 22 33 44 55 66 77



etc

GatherDesign

Scenarios

Create

88 99

Define

Purpose

ActConclude

6

Design Considerations (for each test) …

• What kind of test

• Institutions to be included

• Data sources

• Methodology (accounting or market based)

• Approach (Top down, bottom up or combination)

• Metrics

• Models

• Period(s) to be assessed

• Scenarios or sensitivities

• Risks to be assessed

• Modelling assumptions (eg fixed balance sheet)

• Behavioural assumptions

• Calibration

• Regulatory / accounting standards to apply

• Validation

• Reporting requirements7*things you should agree on and document before you start

Design Stage

• Is their a governance framework and what is it (this matters a lot) ?

• Is there senior commitment to the process ?

• What is the scope of the tests (this will frequently change) ?

• Who has overall responsibility for the exercise ?

• Who are they accountable to ?

• What is the needed level of engagement, horizontal and vertical ?

• What performance metrics are to apply and how they will be monitored ?

• What are the practical limitations

– budget,

– Resources

– time

8*things you should sort out before you start

Design Stage

• Types of tests to be run

– Solvency

– Liquidity

– Contagion

• Institutions to be included– Banks

• All banks ?

• Proportion of banks

• SIFIs ?

– Non Banks• Insurance companies ?

• Pension Funds ?

• Other


Sample of Stress testing Measures …

• Market Risk (interest rates and FX rates)– VAR– Capital Adequacy (CAR)

• Credit Risk – Risk Weighted assets – Regulatory capital (Tier 1&2)– Capital Adequacy (CAR)– Economic capital– Leverage ratio– Value at risk (VAR)

• Liquidity (Market and Funding)– Ratios, – Survival days– Asset Values

• Contagion– Capital adequacy

• Spillover Risk– Capital adequacy (CAR)

• Operational Risk– VAR (frequency and severity)– Capital adequacy (CAR

• General – Financial Soundness Indicators

(FSIs and CAELs)– Break even point (reverse stress

testing) • Integrated Liquidity & Solvency

– Capital adequacy (CAR)– Liquidity coverage– Leverage– Network effects– System impacts

Capital Adequacy is a good general metric, including for solvency tests …

Design Stage – how are your metrics defined

• Eg for Capital Adequacy, what are the required inputs

• Is the data available

• Can it be modelled


𝐶𝑅𝑡+1 =𝐶𝑡 + (𝑂𝐼𝑡+1 − 𝐿𝑆𝑡+1 − 𝑇𝑋𝑡+1 − 𝐷𝑉𝑡+1 + 𝐶𝐼𝑡+1)

𝑅𝑊𝐴𝑡 + 𝛥𝑅𝑊𝐴𝑡+1

Where:

C = Capital

OI = Operating Income

L = Losses

TX = Taxes

DV = Dividends

CI = Capital Injection

Where is the data to come from …

Credit and Macro Economic Data

Analysis

Raw Credit DataRaw Macro

Economic Data

Market price based

EconometricsRule of Thumb

Expert Opinion

Analysis and Reconciliation

Stress Testing Models

(Single & Multi Period)

Cleansed Credit & Macro Economic

Data

Bench marking

Price Data

Simulations

What actions are intended …

What is to happen to the results:

• Who is to review it, approve it

• What are the feedback loops

• Ad hoc or repeatable process (streamlining0

What procedural actions can be expected in the short term:

• Reruns under different assumptions

• Corrections to data or methodology

• Required responses

What substantive actions are expected to result from the tests

• Restructuring, capital injection, revised methodology or procedures etc

13

In subsequent presentations we will examine the other stages…

Apply Shocks

Start Date Data

Historical Data

Start Date Data


Measure

Shock

Shocked Output

Re-Study

Re-Measure

11 22 33 44 55 66 77



etc

GatherDesign

Scenarios

Create

88 99

Define

Purpose

ActConclude

14

Questions and discussion …

15

Documents

Regional Training on Micro Prudential Stress Testing · 2017-09-09 · • A means of identifying and quantifying the inter relationship between risks (e.g. market, liquidity and