• ST-1.5 ST-1.5 Stress Testing Approaches and Methodologies

    • General Requirements

      • ST-1.5.1

        Conventional bank licensees must adopt an integrated approach to stress testing and conduct stress tests on a firm-wide basis and on a consolidated basis where applicable, providing a spectrum oi perspectives at product-, business- and entity-specific levels. Where the bank is part of a larger banking group, its stress tests must also take into account the potential spillover effects and inter-dependence among members of the group.

        July 2018

      • ST-1.5.2

        Stress tests must be regularly conducted, at least on a biannual basis. Tests must consider the nature of the risks involved and the purpose of the stress tests. Stress scenarios must be coherently developed so that risks that are inherently linked (e.g. market risk and credit risk) can be assessed together across portfolios and across time. The bank may refer to Section ST-2.2 for any available guidance on stress testing for specific risks.

        July 2018

      • ST-1.5.3

        The conventional bank licensee may also conduct ad hoc stress tests on specific areas whenever this is warranted. The situations which warrant ad hoc stress testing may include market volatility, changes to the risk profile of large counterparties, deteriorating economic conditions domestically or globally, political events, new product development or new market entry, significant changes in business operations and changes in applicable laws and regulations.

        July 2018

      • ST-1.5.4

        The scope of a stress test exercise must reflect the significant activities undertaken by the conventional bank licensee and consider all material risks affecting the bank. The assessment of material risks must include the following major risk categories or activities:

        (a) Credit risk;
        (b) Market risk;
        (c) Interest rate risk in the banking book;
        (d) Liquidity risk, including funding liquidity risk;
        (e) Operational risk; and
        (f) Other material risks.
        July 2018

    • Methodologies and Techniques

      • ST-1.5.5

        Conventional bank licensees must use a range of quantitative and qualitative stress testing techniques and perspectives, depending on the complexity of risk and adequacy of data.

        July 2018

      • ST-1.5.6

        A quantitative measurement approach must provide the foundation of the stress testing framework. In measuring risks, a conventional bank licensee must establish quantitative approaches that appropriately reflect methodologies and standards that are well accepted in the industry. Quantification of risks and losses must be estimated based on credible data. However, quantitative techniques must be adequately enhanced with qualitative techniques and expert judgment to overcome limitations in data and systems. Meaningful qualitative techniques must be developed for stress testing risk factors that are not easily quantifiable.

        July 2018

      • ST-1.5.7

        Conventional bank licensees must ensure that the data used for stress testing is representative of, and bears similar risk characteristics to, the specific products or risk profile of the bank. In cases where there are data limitations, proxy estimates can be used. However, banks must apply a margin of conservatism to proxy estimates.

        July 2018

      • ST-1.5.8

        Conventional bank licensees must use, based on its risk profile, a suitable range of stress testing methodologies to ensure that its stress testing programme is comprehensive. In conducting scenario analysis, banks must assume a dynamic balance sheet rather than a static balance sheet. Banks must project growth (or decline) in balance sheet size under the chosen stressed conditions.

        July 2018

      • ST-1.5.9

        A sensitivity analysis estimates the impact of a single risk factor or a small number of closely-related risk factors (e.g. interest rates, FX rates, real estate price, equity price etc.) on asset value, asset quality, earnings, capital or liquidity ratios. In most cases, sensitivity tests involve changing inputs or parameters without relating those changes to an underlying event or real-world outcome. While it is helpful to draw on extreme values from historical periods of stress, sensitivity tests should also include hypothetical extreme values to ensure that a wide range of possibilities are included.

        July 2018

      • ST-1.5.10

        A scenario analysis simulates the impact of a combination of risk factors on the bank's profitability, capital adequacy and liquidity. The adverse movements of risk factors is usually driven by macroeconomic or political events, financial market movements, deterioration in industry fundamentals or a bank-specific event. These stress scenarios can be based on historical or hypothetical events (see Section ST-2.3).

        July 2018

      • ST-1.5.11

        Stress tests should also account for interactions between credit, funding and asset market conditions in a stressed scenario. The following interactions may be considered:

        (a) Credit deterioration of obligors leading to a reduction in cash inflows;
        (b) Price shocks for specific asset categories (for example, fire sales and significant mark-to-market losses) resulting in the drying up of liquidity for such assets;
        (c) Reduction of eligible high quality liquid assets ('HQLA') due to issuer downgrades;
        (d) Increase in bank's liquidity needs as a consequence of higher drawdown of committed credit lines (for example, higher crystallisation of undrawn credit lines);
        (e) Additional posting of collateral or margin due to a downgrade of the bank's credit rating or adverse price movements; and
        (f) Restricted access to secured or unsecured funding markets due to a deterioration in the bank's financial strength and credit rating.
        July 2018

    • Reverse Stress Testing

      • ST-1.5.12

        Apart from assessing and being prepared to respond to stressed conditions, Bahraini conventional bank licensees must also be aware of the scenarios that can render its business non-viable, due to severe financial or reputational damage. Banks must, therefore, implement a reverse stress testing program to identify the scenarios or events that can threaten the viability or solvency of the bank.

        July 2018

      • ST-1.5.13

        Reverse stress tests start from a known stress testing outcome, such as a breach of regulatory capital ratios, illiquidity, insolvency, or the cancellation of banking licence, and then work backwards to identify the events that could lead to such an outcome for the bank.

        July 2018

      • ST-1.5.14

        Reverse stress testing must serve as a starting point for determining the scenarios for recovery planning. Given that stress testing helps in understanding the quantum and the direction of impact of various scenarios on the Bahraini conventional bank licensee's critical risk metrics, the process of defining the recovery triggers must also be informed by stress testing

        July 2018

    • Expert Judgment

      • ST-1.5.15

        Conventional bank licensees must ensure qualitative judgment and perspective from relevant experts such as risk controllers, economists, business managers and traders within the bank are incorporated into the stress testing programme to help supplement the mechanical analysis performed by models, assess the impact of extreme events which are difficult to model statistically because, by definition, they occur very rarely and analyse and respond to fast-changing market conditions.

        July 2018

      • ST-1.5.16

        The designated unit responsible for managing and coordinating the stress testing programme should facilitate internal dialogue and debate among the relevant experts and take into account their opinions, as appropriate, in the design, implementation and use of the stress tests.

        July 2018

    • Alignment with Recovery Planning Program

      • ST-1.5.17

        Bahraini conventional bank licensees must test their recovery plan against three types of scenario at a minimum:

        (a) Idiosyncratic scenario;
        (b) Market-wide scenario; and
        (c) Scenario with a combination of both components.
        July 2018

      • ST-1.5.18

        Bahraini conventional bank licensees must adopt more than one scenario within each of the three scenario types.

        July 2018