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  • CA-9.7 CA-9.7 Stress testing

    • CA-9.7.1

      Banks that use the internal models approach for calculating market risk capital requirements must have in place a rigorous and comprehensive stress testing programme. Stress testing to identify events or influences that could greatly impact the bank is a key component of a bank's assessment of its capital position.

    • CA-9.7.2

      Banks' stress scenarios need to cover a range of factors that can create extraordinary losses or gains in trading portfolios, or make the control of risk in those portfolios very difficult. These factors include low-probability events in all major types of risks, including the various components of market, credit and operational risks. Stress scenarios need to shed light on the impact of such events on positions that display both linear and non-linear characteristics (i.e., options and instruments that have option-like characteristics).

    • CA-9.7.3

      Banks' stress tests should be both of a quantitative and qualitative nature, incorporating both market risk and liquidity aspects of market disturbances. Quantitative criteria should identify plausible stress scenarios to which banks could be exposed. Qualitative criteria should emphasise that two major goals of stress testing are to evaluate the capacity of the bank's capital to absorb potential large losses and to identify steps the bank can take to reduce its risk and conserve capital. This assessment is integral to setting and evaluating the bank's management strategy and the results of stress testing should be routinely communicated to senior management and, periodically, to the bank's Board of Directors.

    • CA-9.7.4

      Banks should combine the use of stress scenarios as advised under (a), (b) and (c) below by the Agency, with stress tests developed by the banks themselves to reflect their specific risk characteristics. The Agency may ask banks to provide information on stress testing in three broad areas, as discussed below.

      (a) Scenarios requiring no simulation by the bank

      Banks should have information on the largest losses experienced during the reporting period available for review by the Agency. This loss information will be compared with the level of capital that results from a bank's internal measurement system. For example, it could provide the Agency with a picture of how many days of peak day losses would have been covered by a given value-at-risk estimate.
      (b) Scenarios requiring simulation by the bank

      Banks should subject their portfolios to a series of simulated stress scenarios and provide the Agency with the results. These scenarios could include testing the current portfolio against past periods of significant disturbance, for example, the 1987 equity crash, the ERM crises of 1992 and 1993 or the fall in the international bond markets in the first quarter of 1994, the Far East and ex-Soviet bloc equity crises of 1997–99 and the collapse of the TMT equities market of 2000–01 incorporating both the large price movements and the sharp reduction in liquidity associated with these events. A second type of scenario would evaluate the sensitivity of the bank's market risk exposure to changes in the assumptions about volatilities and correlations. Applying this test would require an evaluation of the historical range of variation for volatilities and correlations and evaluation of the bank's current positions against the extreme values of the historical range. Due consideration should be given to the sharp variation that, at times, has occurred in a matter of days in periods of significant market disturbance. The four market events, cited above as examples, all involved correlations within risk factors approaching the extreme values of 1 and –1 for several days at the height of the disturbance.
      (c) Scenarios developed by the bank to capture the specific characteristics of its portfolio

      In addition to the general scenarios prescribed by the Agency under (a) and (b) above, each bank should also develop its own stress scenarios which it identifies as most adverse based on the characteristics of its portfolio (e.g. any significant political or economic developments that may result in a sharp move in oil prices). Banks should provide the Agency with a description of the methodology used to identify and carry out the scenarios as well as with a description of the results derived from these stress tests.

    • CA-9.7.5

      Once a stress scenario has been identified, it should be used for conducting stress tests at least once every quarter, as long as the scenario continues to be relevant to the bank's portfolio.

    • CA-9.7.6

      The results of all stress tests should be reviewed by senior management within 15 days from the time they are available, and should be promptly reflected in the policies and limits set by management and the Board of Directors. Moreover, if the testing reveals particular vulnerability to a given set of circumstances, the Agency would expect the bank to take prompt steps to manage those risks appropriately (e.g., by hedging against that outcome or reducing the size of its exposures).