Introduction

Stress testing is an integral tool when it comes to risk identification and mitigation. The importance of stress based risk management has been further accentuated of late. With increasing regulatory scrutiny, banks are required to conduct more comprehensive and rigorous stress tests. Stress exercises and tools are now more integrated with the overall risk management framework and are recognised as key component of a more contemporary approach. Stress testing is an analytical practice for subjecting an institution to a hypothetical, yet conceivable adverse scenario. The main purpose is to calculate the impact of a potential adverse scenario on the condition and performance of the bank.

Key findings

• Key Drivers – A combination of external regulatory requirements and internal schemes have acted as a catalyst to perform stress tests on a regular basis. A contingency plan can subsequently be devised in order to mitigate the risk resulting from a potentially deteriorating environment.

• Regulators: Driving Forward: Using Basel II as their guiding principle, Basel III will act as a pillar to assert the strengthening of risk management requirements for credit risk exposures. However, the recently announced reforms will not be implemented until 2019 – what impact does the current situation have on the ongoing volatile market conditions?

• Stress Test Frequency: Stress testing on a regular basis enables firms to recognize the banks risk and act on the results in a necessary manner. Since the crisis, the profile of stress testing has been raised and more regularity has become paramount in understanding credit risk exposures.

• Technology: The use of technology in financial institutions has grown exponentially and will continue to do so at a consistent rate as IT companies and vendors build better, powerful and faster systems. Producing a set of standardized credit risk tools ensures an efficient method of tracking and reporting credit risk.

• Future Initiatives: Are firms beginning to implement stress testing as part of a norm or are banks straying away from their risk exposure? This section looks at what banks have in the pipeline.

Conclusion

In the light of the crisis financial institutions have become more risk aware which has been replicated through senior management’s prudency in risk management. As this study has revealed two out of the three banks have an Enterprise-Wide-Group and an Executive Committee (similar roles) which assess stress testing on an enterprise level and various other risk activities.

To obtain a free copy of this section in full, please contact us at marketing@lepus.com with your name, job title, firm, phone number and email.

Tagged with: 2010, regulatory, risk management, Risk Research Report, stress testing