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  • CA-14.7 CA-14.7 Stress Testing

    • CA-14.7.1

      Conventional bank licensees 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 conventional bank licensee is a key component of a conventional bank licensee's assessment of its capital position.

      January 2015

    • CA-14.7.2

      Conventional bank licensees' stress scenarios must 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 must 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).

      January 2015

    • CA-14.7.3

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

      January 2015

    • CA-14.7.4

      Conventional bank licensees must combine the use of stress scenarios as advised under Subparagraphs (a), (b) and (c) by the CBB, with stress tests developed by the conventional bank licensees themselves to reflect their specific risk characteristics. The CBB may ask conventional bank licensees to provide information on stress testing in three broad areas, as follows:

      (a) Scenarios requiring no simulation by the bank:

      Conventional bank licensees must have information on the largest losses experienced during the reporting period available for review by the CBB. This loss information will be compared with the level of capital that results from a conventional bank licensee's internal measurement system. For example, it could provide the CBB 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:

      Conventional bank licensees must subject their portfolios to a series of simulated stress scenarios and provide the CBB with the results. These scenarios could include testing the current portfolio against past periods of significant disturbance, for example, the 9/11 attacks on the USA, the 1987 equity market crash, the Exchange Rate Mechanism crises of 1992 and 1993 or the fall in the international bond markets in the first quarter of 1994, the 1998 Russian financial crisis, the 2000 bursting of the technology stock bubble or the 2007/2008 sub-prime crisis, 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 conventional bank licensee'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 conventional bank licensee's current positions against the extreme values of the historical range. Due consideration must be given to the sharp variation that, at times, has occurred in a matter of days in periods of significant market disturbance. For example, the above-mentioned situations involved correlations within risk factors approaching the extreme values of 1 and -1 for several days at the height of the disturbance; and
      (c) Scenarios developed by the bank to capture the specific characteristics of its portfolio:

      In addition to the general scenarios prescribed by the CBB under Subparagraphs (a) and (b), each conventional bank licensee must 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). Conventional bank licensees must provide the CBB 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.
      January 2015

    • CA-14.7.5

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

      January 2015

    • CA-14.7.6

      The results of all stress tests must be reviewed by senior management within 15 days from the time they are available, and must 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 CBB requires the conventional bank licensee to take prompt steps to manage those risks appropriately (e.g., by hedging against that outcome or reducing the size of its exposures).

      January 2015

    • CA-14.7.7

      Conventional bank licensees must conduct, at least weekly, a set of pre-determined stress-tests for the correlation trading portfolio encompassing shocks to default rates, recovery rates, credit spreads, and correlations. Appendix CA-19 provides guidance on the stress testing that must be undertaken to satisfy this requirement.

      January 2015