Introduction

Following the financial crisis, the banks have witnessed unprecedented levels of scrutiny from regulators. When faced with unforgiving public opinion and continuing market volatility, institutions face significant challenges in re-establishing financial strength. To restore credibility institutions have been assigned the task of building upon their stress testing processes and frameworks to deliver greater transparency, insight and stability. Stress based risk management has therefore emerged as one of the foremost priorities for the financial services industry. To this end, banks are heavily focused on implementing more robust and comprehensive infrastructure to facilitate more timely and meaningful results.

Key Findings

• Joint Stress Testing – 34% of the surveyed institutions possess the capability to stress test market, credit and liquidity risk jointly. A further 18%, consisting of more sophisticated firms, can do so for operational risk as well. Nearly 70% of these banks are also attempting to stress risks in a more holistic manner.

• Running Firm-wide Stress Tests – Although half of the surveyed banks have a strong ability to run firm wide stress tests and scenario analysis, only 3% of the participating sample believed that no further improvements were required.

• Key Drivers – Regulatory initiatives have only been secondary drivers for over half the participating firms, with a further 9% stating that these endeavours have been driven internally.

• Updating Scenarios – In general, market risk scenarios are changed daily, and credit risk scenarios are reassessed quarterly by most participants. With the emerging pre-eminence of liquidity risk after the crisis, it is of no surprise that nearly half of the firms alter their scenarios either daily or monthly.

• Vendor Strategy – 65% of respondents rely on in-house software, while 25% tend to use a mixture of in-house and external packages. Vendors are popular in the areas of collateral management, economic capital calculations, obtaining quality market data and consolidation of exposures.

Conclusion

Considerable increases in budgets, the vigour of regulators, clear identification of shortcomings and priorities, and renewed interest by senior management have patently escalated stress testing to immediacy. Given the dynamism and increasing sophistication of financial markets, this pursuit necessitates that the stress testing infrastructure be equipped with automation and flexibility, such that evolving circumstances can be feasibly incorporated. With sufficient planning prior to building the architecture, achieving this paradigm need not involve a compromise between the many features that lend stress testing its virility.

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