Methodologies and Techniques
ST-1.5.6
Islamic 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 2018ST-1.5.7
A quantitative measurement approach must provide the foundation of the stress testing framework. In measuring risks, an
Islamic 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 judgement to overcome limitations in data and systems. Meaningful qualitative techniques must be developed for stress testing risk factors that are not easily quantifiable.July 2018ST-1.5.8
Islamic 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 2018ST-1.5.9
Islamic 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 2018ST-1.5.10
A sensitivity analysis estimates the impact of a single risk factor or a small number of closely related risk factors (e.g. rates of return, 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 2018ST-1.5.11
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 2018ST-1.5.12
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) Deterioration of return on financing assets 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 financing facilities (for example, higher crystallisation of undrawn financing facilities);(e) Additional posting of collateral or margin due to a downgrade of the bank's 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 rating.July 2018
