regional training on micro prudential stress testing testing 2017...regional training on micro...

Regional Training on Micro Prudential Stress Testing

METACBeirut, Lebanon 20th – 24th Feb 2017

Day 1, Session 2Introduction to Stress Testing

Michael Lau, consultant LA

Introduction

• The meaning of stress testing

• Parallel developments

• Evolution of Stress testing Guidelines and Practices

• Next Steps

• Overview of the stress testing process

• Selected models

2

What are stress tests

1. They are an assessment of the impact(s) of hypothetical change

2. Are a forward looking measure (cf with FSIs which are backward looking)

3. Can produce an outcome measured in terms of a single metric (eg capital adequacy) or multiple metrics (eg FSI’s or even fully integrated financials)

4. Can test a product, a business unit, an entity, portfolio of common elements (eg industry sectors), or a banking system as a whole

5. Can test credit, market, operational, liquidity and other risk (eg reputation)

6. Can be quantitative, qualitative or a combination of both

7. Can use one or more of many available methodologies

8. Can require small or large amounts of data depending on test applied

9. Can be run routinely or at ad hoc intervals

10. The is no right way to stress test, each method will have advantages and disadvantages

11. Test should apply the Principle of Proportionality (ie level of testing and analysis should related to the size, complexity and level of risk taking)

12. Financial sector stress testing is constantly evolving (eg attention to liquidity solvency interaction, feedback effects, and non linearities)

Stress Testing Timeline*

Date Banking Regulation Stress Testing (advanced) Stress Testing (emerging)

Pre

1988

No broad banking regulation No common stress testing

practices

Sensitivity testing for Market

Risk

Ad hoc regulation Market risk sensitivity testing

Market risk VAR testing

Interest rate risk sensitivity

Monte Carlo simulations

1988 1st Basel Accord (Basel I)

consultations

No requirements for credit

stress testing

Sensitivity testing for Market

Risk continues

Capital calculations Led by product development

1992 1st Basel Accord (Basel I)

becomes effective

No requirements for credit

stress testing

Used for product signoffs

2004 2nd Basel Accord (Basel II)

consultations

Still largely independent

development by banks

Basel I adopted. No

requirement for stress testing

Focus on credit risk Developing requirements for

Credit Risk testing

Some discretionary credit risk

stress testing

Intro of Market Risk Capital Market Risk testing as above VAR used for market risk

Intro of Operating Risk Capital Introduction of Op Risk testing No operating risk testing

* Note that the stress testing comments are intended to align with the year and not the Banking regulation

Stress Testing Guidelines and Practice (continued)


2006 2nd Basel Accord (Basel II)

becomes effective

Requirements for Credit risk

capital

Requirements for “rigorous

forward looking” Credit Risk

stress testing

Basel II not adopted by emerging

countries. Continued growth of

sensitivity testing for credit risk

Requirements for Market

Risk capital

Requirements for Market Risk

stress testing

Use of simple VAR for Market Risk

Requirements for Operation

Risk capital

Slow development of Operating

Risk Stress testing techniques

No requirement but some

development of Op risk testing

AIRB methods for Credit Risk

and some advanced methods

for Op Risk

Globally active banks

•Sensitivity testing (single period)

•Scenario testing (single & multi

period)

•Extensive data histories available

•Complex quantitative models

used

Stress Testing Guidelines and Practice (continued)


2006 Core Principles for Effective

Banking Supervision - Consult

Designed to cover all banks Banks would be required to

have forward-looking stress

testing programmes

Concepts selectively adopted in

basic form.

Models still mainly sensitivity

testing

Emphasises proportionality To be commensurate with risk

profile & systemic importance

Requirement to stress credit,

market liquidity and op risk

2008 Global Financial crisis

Complex models often failed to

capture risks (esp tail risks):

Continued experimentation with

sensitivity testing

Unrecognised contagion risks Similar banking weaknesses but

Poor governance practices Less complex banking sectors

Unrecognised concentrations Less interbank exposures

Unrecognised non linearities Less wholesale funding

Unrecognised liquidity risks Stress testing failure not so great

Lack of integration of risks

Weak valuation processes

Evolution of Stress Testing (continued)


2008 Principles of Sound Liquidity

Risk Management

Revised stress testing

requirements

New stress testing requirements

targeted at advanced banks only

Test for ratios Concepts selectively adopted

2009 Revisions to the Basel II

Market Risk framework

2009 US Supervisory Assessment

Program tests (SCAP)

Obliged to build capabilities

2009 Principles for Sound Stress

Testing

50% of countries perceived to be

at an “early stage”

Principles are relevant for emerging markets

(see next slide) Continuing development of

complex quantitative models

Continuing development of simple

single period sensitivity testing

Focus on individual risks in silos Only limited multi period testing

Limited use of integrated P&L

and BS approaches

Focus on solvency testing through

impact on CAR

Testing for PD and LGD

migration, correlations and

concentrations

Testing liquidity including funding impacts

Evolution of Stress Testing (continued)Date Banking Regulation Stress Testing (advanced) Stress Testing (emerging)

2010 First EBA Stress Tests2010/11 3rd Basel Accord (Basel III)

Leverage ratio Revision of section in Basel II on

stress testing

Basel III not being adopted but

providing a useful reference

Tier 1 increase (CEq) Qualitative requirements when

using IR models is expanded

Still using simple models.

Limited by availability of data

Other Tier 1 increase Monthly stress testing of market

risk exposures

Credit risk testing for impacts

on NPLs, large exposures etc

Capital Conservation buffer

(CEq)

Requirement for multi factor

scenario testing including non

directional risk testing

More scenario based sensitivity

testing on credit, interest rate

and FX risk

SIFI surcharges (CET1 req) Extreme but plausible events Limited by data availability

Counter cyclical buffer (CEq) Reverse stress testing

Liquidity Coverage Ratio (LCR) Testing of market movements on

exposures and counterparty

credit worthiness

Some attempts at adoption of

Basel III liquidity ratios.

Net Stable Funding Ratio

(NSFR)

Testing of large exposures,

concentrations and correlations

Global banks are undertaking

own stress testing

Stronger treatment for

securitisation, trading &

derivatives

Senior management to take a

lead role in the stress test

management framework

Basic in house models used.

Some transfer of stress testing

knowledge between banks



2011 Second EBA Stress Tests

US CCAR & CPAR Stress Tests

2012 Core Principles for Effective

Banking Supervision

becomes effective

Requirement for forward looking

stress testing commensurate

with risk profile and systemic

importance

Continued development of

simple in house models, still

largely excel based single period

models

Requirement to adopt plausible

adverse scenarios

Bank to integrate results into

decision making and risk

management

Some Central banks using IMF

single period model

2012 Thematic peer review Availability of IMF multi period

model, requires training

US CCAR & DFAST stress tests

2013 Start of phase-in of Basel III

capital standards

Revised liquidity standards

US CCAR & DFAST Stress Tests


Date Banking Regulation Changes Stress Testing (advanced) Stress Testing (emerging)

2014 EBA Stress Tests Increased use of monte-carlo

simulation

Increasing awareness of

advanced techniques

US CCAR & CPAR Stress Tests Development of DSGE type

models

Implementation constrained by

lack of data and expertise

BoE Stress Tests Increasing focus on liquidity

solvency interaction

HKMA Stress Tests Incorporation of feedback effects

China Stress Tests Increased use of market price

based models

2015 Application of Basel III

framework

Development of network models

and other techniques to model

contagion and spill over effects

Continued rollout of single

period models

2016 Further development in all areas Further experimentation with

multi period models

Still focus on solvency testing

and early stage liquidity testing

2016 New Standards for IRRBB Steadily growing interest

2016 Min Capital requirements for

Market Risk

Enhancement of models in line

with regulatory developments

Continued rollout of simple

excel models

Types of Stress Tests explained …

• Single period / multi period

• Single variable / multi variable

• Top down / Bottom up etc

• Portfolio / Sector / Bank / Non Bank / System level

• Accounting based / Market Price based

• Direct / Indirect assumptions

• Solvency / Liquidity / Liquidity solvency integrated

• Integrated / non integrated

• Macro prudential / micro prudential

• Internal / external

• Ad hoc / regular

11

Objectives of this course

To learn how to set up and run a straightforward single period stress testing process• How to design the tests• How to set up the model• How to stream line the model updating process• How to run checks on the data• How to analyze the banks as part of the set up process• How to set up assumptions• How to run credit, interest rate, FX, Liquidity, and contagion related

sensitivity tests• How to combine these tests into a single scenario• How to run reverse stress tests• How to analysis the results• How to report on the results• How to view bank level and system level results• How to adapt the model to suit your own requirements

12

A stylized stress testing process (9 stages)

13

Doted lines reflect feedback which can generate new iterations. Although here pivoting around the start date analysis they can start at any stage and refer back to any stage

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

Single Period Model (Sensitivities & Scenarios)

14

Data Assumptions

Credit RiskInterest

Rate RiskFX Risk

Liquidity Risk

Scenarios

Cihak ModelCihak Model

Reverse Stress Tests

Bottom Up

Interbank

Multi Period Model (Sensitivities & Scenarios)

15

Historical Data

Market Prices(eg FX rates,

equities)

Risk Factors(eg NPLs, PDs, LGDs)

Finance Factors(eg NII, Expenses, Assets, Liabilities)

Heuristics/benchmarkeing

Expert Opinion

Validation

Multi Entity / Multi Period Risk & Financial ModelCovers stress Horizon eg 3 to 5 years

Can incorporate liquidity impacts

Satellite ModelsInput generators Macro economic factors Risk Factors Growth factors Profitability factors Concentration factors CorrelationsMarket Price Based Models

Period on Period Balance Sheet

Period on Period P&L

Base date data

Historical data

Parameters and core assumptions

Period on Period ScenarioP&L and Balance sheet

Assumptions not included in satellite model outputs

Shock assumptions

Period on Period Off-Balance Sheet

Base date data

OutputIterations

Iterations

Market price modelling

Macro Economic Factors

(eg GDP, CPI)

Market Prices(eg FX rates,

equities)

Current Data

Output

Vulnerabilities

Losses by risk type

Thresholds & Metrics

RWA and CAR

Liquidity Outcomes

Recapitalisation needs

Liquidity and spillover implications

Output

Alternative Non Integrated

Version

A B

Basedate analysis

Challenger Models

EXAMPLE ARCHITECTURE OF A MULTI-VARIABLE / MULTI -PERIOD STRESS TESTING MODEL

EXAMPLE ARCHITECTURE OF A MULTI-VARIABLE / MULTI -PERIOD STRESS TESTING MODEL

Iterations

Questions and discussion …

16

Appendices

17

A look at Basel 2009 Stress Testing Principles for Banks

• P1: Stress testing to form an integral part of overall governance & risk mgmt

• P2: Should promote risk identification and control

• P3: Should take into account a range of views, perspectives and techniques

• P4: Should have policies and procedures

• P5: Should have suitably robust infrastructure

• P6: Should regularly maintain and update framework, assess effectiveness

• P7: should cover a range of risks and business areas

• P8: Should cover a range of scenarios

• P9: Should feature a range of severities

• P10: Should take into account numerous pressures in markets

• P11: Should be systematically challenged

• P12: Should cover complex and bespoke products

• P13: Should cover pipeline and warehousing risks

• P14: Should capture effect of reputation risk, eg off balance sheet exposures

• P15:Should enhance approach for assessing wrong way risk

18

A look at the Basel 2009 Stress Testing Principles for Supervisors

• P16: Should make regular and comprehensive assessments

• P17 Should require corrective action if material deficiencies identified

• P18: Should assess/challenge scope and severity of scenarios

• P19: Should examine results for capital and liquidity adequacy

• P20: should consider common scenarios

• P21:Should engage in constructive dialogue, have capacity and skills

19

regional training on micro prudential stress testing testing 2017...regional training on micro...

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