CA-9.7.4
Banks should combine the use of stress scenarios as advised under (a), (b) and (c) below by the Central Bank, with stress tests developed by the banks themselves to reflect their specific risk characteristics. The Central Bank 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 Central Bank. 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 Central Bank with a picture of how many days of peak day losses would have been covered by a givenvalue-at-risk estimate.
Banks should have information on the largest losses experienced during the reporting period available for review by the Central Bank. 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 Central Bank with a picture of how many days of peak day losses would have been covered by a given
(b) Scenarios requiring simulation by the bank
Banks should subject their portfolios to a series of simulated stress scenarios and provide the Central Bank 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 riskexposure 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.
Banks should subject their portfolios to a series of simulated stress scenarios and provide the Central Bank 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
(c) Scenarios developed by the bank to capture the specific characteristics of its portfolio
In addition to the general scenarios prescribed by the Central Bank 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 Central Bank 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.
In addition to the general scenarios prescribed by the Central Bank 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 Central Bank 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.
October 07