OSFI Stress Testing Flashcards
List purposes of stress testing
- Risk identification and control
- Complementary other risk management tools
- Supporting capital management
- Improving liquidity management
List general considerations for stress testing programs
- Consider different techniques and views from different experts in the org
- Appropriately doc
- Robust infrastructure, but flexible enough to accommodate evolving stress test
- Assessed regularly and indep
Provide relevant risks that may be included in stress testing
Different risk: • Contagion • Insurance • Inflation • Liquidity • Market • New business • Operational and legal • Regulatory • Securitization • Credit risk • Concentration • Risk to reputation
Provide typical measures used for the impact of stress tests
- Asset and liability values
- Accounting profit/loss
- Economic profit/loss
- Economic capital
- Level of impaired assets and write-offs
- Liquidity and funding gaps
- Required and available regulatory capital
List features of methodolody and scenario selection for stress testing
- Cover a range of risks and business areas (provide a complete picture of companywide risk)
- Over a range of scenarios (incl. non historical scenarios, considering interactions and feedback effect)
- Cover a range of severities (incl. events capable of generating the most damages)
A “failure of imagination” could lead to an underestimation of the likelihood and severity of extreme events and to a false sense of security about an institution’s resilience
What is the difference between stress test and reverse stress test?
Stress test would test outcome arising from changes in circumstances. Reverse stress test would start from an outcome challenging viability of the firm, and backwards, find a scenario that would bring this outcome.
Provide specific areas of focus where stress testing should be prominent if specific risks are material
- Risk mitigation (Re): Stress testing should facilitate risk mitigation or contingency plans
- Risk to reputation: Should have an approach to mitigate reputational risks and maintain market confidence
- Risk concentration: By region, industry, risk factor, and off-balance or contingent exposures
- Counterparty credit risk: Assess large exposures to leveraged counterparties (banks, funds, etc.) that may be particularly exposed to market movements
- Securitization and Warehousing Risks: Consider complex and customized products along with warehousing risks
Define Stress testing
Risk management technique to evaluate potential effects of financial condition of a change in risk factor caused by an exceptional but plausible event
Define the purpose of stress testing:
Risk identification and control
Used to address institution-wide risks, and consider the concentrations and interactions between risks in stress envs that might otherwise be overlooked
Define the purpose of stress testing:
Complementary other risk management tools
- Allows for the simulation of shocks which have not previously occurred
- Assess the robustness of models to possible changes in the economic environment
- Help detect vulnerabilities such as unidentified risk concentrations or potential interactions.
Define the purpose of stress testing:
Supporting capital management
Should be part of institution’s capital management: identify events that adversely affect the firm
Define the purpose of stress testing:
Improving liquidity management
- Assessing the institution’s liquidity profile
* Assessing the adequacy of liquidity buffers
Describe roles of the board with stress testing
- Ultimate responsibility for the overall stress testing program
- Should be aware of the key findings from stress tests
Describe roles of senior management with stress testing
- Program’s implementation, management and oversight
- Ensuring that the institution has adequate plans to deal with remote but plausible adverse scenarios
- Identify and clearly articulate the institution’s risk appetite and understand the impact of stress events on the risk profile of the institution
Contrast Scenario testing and Sensitivity testing
Scenario testing: Hypothetical future state of the world defines changes in risk factors. Longer time horizon, require more resource, more complex
Sensitivity testing: Incremental change in a risk factor (simpler technique, shorter period)
