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STRESS TESTING CASE STUDY

STRESS TESTING CASE STUDY. The process of stress testing is designed to determine the viability of an institution’s capital plan, which will be used to ensure future capital adequacy. That forward capital adequacy is primarily a function of four factors: expected net losses

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STRESS TESTING CASE STUDY

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  1. STRESS TESTING CASE STUDY • The process of stress testing is designed to determine the viability of an institution’s capital plan, which will be used to ensure future capital adequacy. • That forward capital adequacy is primarily a function of four factors: • expected net losses • pre-provision net revenue • the net change in reserves • Size of RWAs.

  2. STRESS TESTING CASE STUDY In teams you are to consider from the perspective of a supervisor what to look for in the approaches taken by banks to assess their capital resilience

  3. STRESS TESTING CASE STUDY • Consider the importance of Scenario selection – i.e. relevance to the circumstances and vulnerabilities of the group • Consider also how robust the selection process is in terms of running multiple interconnected scenarios in order to identify the cumulative impact US Economy European EMEA Other

  4. STRESS TESTING CASE STUDY • Consider the importance of selecting a sufficiently severe but plausible tests in order to deliver a credible and robust outcome

  5. CONSIDER THE ADEQUACY OF THE OUTCOMES IN THE FOLLOWING EXAMPLE OF A CREDIT STRESS TEST The regulatory provisioning requirement under a stress situation is assumed as 1% for all Standard (S); 25% for Substandard (SS), and 100% for all Doubtful categories.

  6. CONSIDER NOW THE ALTERNATIVE APPROACH TAKEN HERE : The downgrade from Standard to NPA (sub standard) is assumed to be 10% (i.e., the extent of present level of gross NPAs) and the provisioning requirements under stress situation are assumed as in example A above:

  7. STRESS TESTING CASE STUDY • Consider the transmission process by which the stresses from scenarios are “crunched” through the accounting and/or modelling engines of the bank • Consider (a) how senior management use the outcomes of stress tests to adjust their business plans/strategies and (b) how the outcomes compare with the supervisory macro-prudential stress tests

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