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  1. P age |1 InternationalAssociationofRiskandComplianceProfessionals(IARCP) 1200GStreet NWSuite800Washington,DC20005-6705USATel:202-449-9750www.risk-compliance-association.com Top10riskandcompliancemanagementrelatednewsstoriesandworldeventsthat(forbetterorforworse)shapedthe week'sagenda,andwhatisnext DearMember, Doyouuse“asuiteofmodels”aspartofyourstress-testingframework? “Itisreasonabletoassumethatanysinglemodelwillalmostcertainlybewrong.” TheBankofEnglandsaysso.Theywilldothesame: “TheBankexpectstouseasuiteofmodelstodothis,ratherthanrelyonasinglemodel. Whyasuiteofmodels? Thereareanumberofbenefits inusingasuiteofmodelsaspartofthestress-testingframework. First,thebankingsystemfacesmanydifferenttypesofrisk,includingmarket,credit,fundingandliquidityrisks. Althoughtheseareofteninterrelated,itisnotrealistic to expectthatasinglemodelwillcapturetheentiretyoftheseriskseffectively. Moreover,relianceonasinglequantitative toolheavilyexposesthestress-testingexerciseto‘modelrisk’. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  2. P age |2 Allmodelsareasimplificationofreality,soitisreasonabletoassumethatanysinglemodelwillalmostcertainlybewrong. Havingrecoursetoasuitehelpsreducethesensitivityoftheresults to aparticularmodel’s‘blindspot’ormiscalibration. Differentmodelsalsogivedifferentinsightsandperspectivestopolicymakers,servingasausefulcross-checktoeach other. Indeed,therangeofoutputsfromdifferentmodels canitselfbeinformative,providingusefulinsights topolicymakersonuncertaintiesaroundbanks’ capitalpositions inagivenscenario. Usingasuiteofmodelsalsoreducestherisk thatindividualbanksmightseekto‘game’thestress-testingframeworkbyseekingtorestructuretheirbalancesheetsinawaythatreducesmeasuredriskunderaparticularmodel. Finally,fromasystem-wideperspective,relyingonasinglemodelcouldhaveadverseconsequencesfordiversityinrisk measurementandriskmanagementpracticesacrossthesystem. Usingasuiteofmodelsisnotwithoutcosts,however.Itwilladdsomedegreeofcomplexitytotheoverallexercise.” Interesting… Ilovedthe“Itwilladdsomedegreeofcomplexity”part. Iwouldaddthatitwillincreasethecostofcompliancetoo.IfwewanttohavemoreCommonEquityTier1(CET1)capital,weneedprofitsandinvestors.Everythingthatincreasesthecostmakesmenervous. ThenewpaperfromtheBankofEnglandisoneofthebestthatcoversthefinancialstresstestingcycle: “Wehaveagreatexampleofthekeystagesoftheannualstress-testingcycle. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  3. P age |3 TheUKFinancialPolicyCommittee(FPC)recommendedinMarch2013that,‘lookingto 2014andbeyond,theBankandPrudentialRegulationAuthority(PRA)shoulddevelopproposalsforregularstresstestingoftheUKbankingsystem. Designcommonscenarios(approximatelytwelveweeks) TheFPC(FinancialPolicyCommittee,establishedundertheBankofEnglandAct1998,throughamendmentsmadein theFinancialServicesAct2012)liaisingwiththePRABoard,willdesignthecommonscenariosfortheforthcominground. Thescenarioswillthenbereleasedtobanks.Itisexpectedthatthedatacut-offwillbeatapproximatelythesametimeasthisrelease. Banks’scenariodesign(approximatelytwelveweeks) In ordertorunthecommonscenariosusingtheir ownmodels,banksarelikelytohavetoextendthenumberofvariablesprovidedbytheBank. Individualbankswillalsolikelyberequiredtodesigntheirown,bespoke,scenarios. Bankswouldbeexpected todomuchofthiswork—forexample,identifyingtherisksthatthebespokescenarioswillarticulate—in parallelwiththedesignofthecommonscenariosbytheFPC. Giventheexpectationthatthebank-specific scenariosshouldbemoreseverethanthecommonscenarios,bankswillhaveafurthermonthtocalibratetheir ownscenariosaftertheyreceivethecommonscenarios. BankswillberequiredtosubmitthebespokescenariosforreviewtothePRA. Independentstress-testinganalysis(approximatelytwelveweeks) StaffattheBankaswellasindividualbanks themselveswillconductthestress-testinganalysisusingthescenariosthathavebeendeveloped. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  4. P age |4 Bankswillalsoneedto identifyrealisticmanagementactionsthatcould betakentoimprovetheircapitaladequacy. Seniorstaffatthebanks shouldbecloselyengagedwithbothaspectsofthisworkandareexpected to beresponsibleforsign-offoftheresultsbeforesubmittingthem tothePRA. Analysisofstress-testresultsandPRAchallengeofbankresults(approximatelytwelveweeks) Bankstaffwillsynthesisetheoutputsacrossthesuiteofmodelstoformasingle,overallviewaboutbanks’performanceineachscenario. ThePRAwillbeinclosediscussionwiththebanksthroughoutthisstage,queryingandchallengingthebanks’ ownresultswhereappropriate. FPCandPRABoardreviewresultsandagreepolicy actions(approximatelyfourweeks) Thestress-testresultswillbeconsideredbytheFPCandthePRABoard. Thetwobodieswillusethis to informtheirjudgementsaroundbankcapitaladequacyatthesystem-wideandinstitution-specificlevel. ThePRABoardwillalsomakeaqualitativeassessmentofbanks’ stress-testingand capitalplanningprocesses,andassesstheadequacyofbanks’ capitalplanstodeterminewhethertheyaresufficienttomeettheoveralllevelofcapitalisationdeterminedbytheFPCandthePRABoard. Publicationofoutcomes TheFPCandPRAwillcommunicatetheoutcomeofthestresstests. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  5. P age |5 ReadmoreatNumber1below. Welcome totheTop10list. BestRegards, GeorgeLekatisPresidentoftheIARCP GeneralManager,ComplianceLLC 1200GStreetNWSuite800,WashingtonDC20005,USATel:(202)449-9750 Email:lekatis@risk-compliance-association.com Web:www.risk-compliance-association.comHQ:1220N.MarketStreetSuite804,WilmingtonDE19801,USA Tel:(302)342-8828 InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  6. P age |6 AframeworkforstresstestingtheUKbankingsystem ADiscussionPaper EIOPAFinalReportonPublicConsultationNo.13/009ontheProposalforGuidelinesonForwardLookingAssessmentofOwnRisks(basedontheORSAprinciples) AspartofthepreparationfortheimplementationofSolvencyII,nationalcompetentauthorities shouldtaketheappropriatestepsin ordertoputinplacefrom1 January2014thepresentGuidelinesontheforwardlookingassessmentof ownrisks (basedontheORSAprinciples). StandardsettingAgendaOfficeoftheChiefauditor Developingandmaintaininghigh-qualityauditingandrelated professionalstandardsisapriorityofthePublicCompanyAccountingOversightBoard("PCAOB"or"Board"). ThePCAOB'sOfficeoftheChief Auditor("OCA")regularlymonitorsauditrisks,challenges,andtheprevailingeconomicenvironmentasitmaintainsandadjustsitsstandard-settingagenda. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  7. P age |7 ProposalforaDIRECTIVEamendingDirective2009/138/EConthetaking-up andpursuitofthebusinessofInsuranceandReinsurance(SolvencyII)asregardsthedatesoftranspositionandapplicationandthedateofrepealofcertainDirectives On19January2011theCommissionadoptedaproposaltoamendDirective2009/138/EC in ordertotakeintoaccountthenewsupervisory architectureforinsuranceandnamelythesettingupoftheEuropeanInsuranceandOccupationalPensionsAgency(EIOPA)on1January2011(COM(2011)8,COD2011/0006)(OmnibusII)andtheentryintoforceoftheLisbonTreatywhichrequiredtheadjustmentofempowermentsfortheCommissiontoadoptimplementingmeasurestoempowermentsfortheCommissiontoadoptimplementinganddelegatedactsaccordingtoArticle290oftheTreatyontheFunctioningoftheEuropeanUnion. SECAwardsMoreThan$14MilliontoWhistleblower WashingtonD.C. TheSecuritiesandExchangeCommissionannouncedanawardofmorethan$14milliontoawhistleblowerwhose informationledtoanSECenforcementactionthatrecoveredsubstantialinvestorfunds. Payments towhistleblowersaremadefromaseparatefundpreviouslyestablishedbytheDodd-FrankActanddonotcomefromtheagency’sannualappropriationsorreduce amountspaid toharmedinvestors. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  8. P age |8 EBAWorkProgramme 2014 ThemainfocusoftheEBA’sregulatorywork willrelateto theCRDIV/CRRlegislation, in particulartocreditandmarketriskandtheprudentialareasofliquidityandleverage,aswellastotherecoveryandresolutionframework. RemarksofChairmanGaryGenslerbeforetheISDAEuropeanConference “Fiveyearsagothisweek,theU.S.economywasinafreefall. FederalReserveChairmanBernanke andthenTreasurySecretaryPaulsonfacedtheunthinkable– askingtheAmericanpeopleto bailoutfinancialinstitutionsto savetheeconomy. Fiveyearsago,theswapsmarketwasatthecenterofthecrisis.” LegislativepackageforbankingsupervisionintheEurozone–frequentlyaskedquestions TheEuropeanparliamenthasadoptedtodayapackageoflegislativeactstosetupasinglesupervisorymechanism(SSM)thatcontains: - aCouncilRegulationtogivespecifictasksrelatedtofinancialstabilityandbankingsupervisiontotheEuropeanCentralBank(ECB); InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  9. P age |9 - aRegulationoftheEuropeanParliamentandoftheCouncildesignedtoaligntheexistingRegulation1093/2010ontheestablishmentoftheEuropeanBankingAuthority(EBA)tothemodifiedframeworkforbankingsupervision. ESMAclarifiesreportingrequirementsforalternativefundmanagers TheEuropeanSecuritiesandMarketsAuthority(ESMA)haspublishedfinalguidelinesonthereportingobligationsforalternativeinvestmentfundmanagers(AIFMs). ESMA’sGuidelines,whichrelatetotheAlternativeInvestmentFund ManagersDirective(AIFMD),willrequireAIFMs–whichincludeshedgefunds,privateequityandrealestatefunds– toregularlyreportcertaininformationtonationalsupervisors. Thereformofinternationalbanking:someremainingchallenges SpeechgivenbyPaulTucker,DeputyGovernorFinancialStability,Memberof theMonetaryPolicyCommittee,MemberoftheFinancialPolicy CommitteeandMemberofthePrudentialRegulationAuthorityBoard,at theOliverWymanInstituteConference,LondonTuesday1October2013 InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  10. P age |10 AframeworkforstresstestingtheUKbankingsystem ADiscussionPaper BackgroundinformationontheFPCandthePRA TheFinancialPolicyCommittee(FPC)wasestablishedundertheBankofEnglandAct1998,throughamendmentsmadeintheFinancialServicesAct2012. ThelegislationestablishingtheFPCcameintoforceon1April2013. The objectivesoftheCommitteearetoexerciseitsfunctionswithaviewtocontributingto the achievementbytheBankofEnglandofitsFinancialStabilityObjectiveand,subjectto that,supportingtheeconomicpolicyofHerMajesty’sGovernment,includingitsobjectivesforgrowthandemployment. TheresponsibilityoftheCommittee,withregardtotheFinancialStabilityObjective,relatesprimarilytotheidentificationof,monitoringof,andtakingofaction to removeorreduce,systemicriskswithaviewtoprotectingandenhancingtheresilienceoftheUKfinancialsystem. TheFPCisaccountable to Parliament. ThePrudentialRegulationAuthority(PRA)isapartoftheBankofEnglandandresponsiblefortheprudentialregulationandsupervisionof banks,buildingsocieties,creditunions,insurersandmajorinvestmentfirms. Itsetsstandardsandsupervisesfinancialinstitutionsattheleveloftheindividualfirm. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  11. P age |11 ThePRAhastwostatutoryobjectives:topromotethesafetyandsoundnessofthesefirmsand,specificallyforinsurers,tocontributetothesecuringofanappropriatedegreeofprotectionforpolicyholders. ItmakesanimportantcontributiontotheBank’scorepurposeofprotectingandenhancingthestabilityoftheUKfinancialsystem. ThePRA’smostsignificantsupervisorydecisionsaretakenbyitsBoard.ThePRABoardisaccountabletoParliament. ForewordbytheGovernor Earlierthisyear,anewregulatoryframeworkcameintoforcein theUnitedKingdom. TheestablishmentofthePrudentialRegulationAuthority(PRA)broughtprudentialsupervisionofbanks,buildingsocieties,creditunions,designatedinvestmentfirmsandinsurancecompanies to theBankofEngland. ThecreationoftheFinancialPolicyCommittee(FPC),responsibleformacroprudentialregulationoftheUKfinancialsystem,filledacleargapinthepre-crisisregulatoryarchitecture. Bothbodieswillhavetomakejudgementsonpossiblethreatstofinancialstability,andwillhave totakeappropriatepolicy andsupervisoryactionstomitigatethesethreats. ThisDiscussionPapersetsoutproposalsforannual,concurrentstresstestsoftheUKbankingsystem. Thestresstestswillprovideaquantitative,forward-lookingassessmentofthecapitaladequacyoftheUKbankingsystemandindividualinstitutionswithinit. TheywillthereforeplayacriticalroleinsupportingboththeFPCandthePRAinmeetingtheirstatutory objectives. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  12. P age |12 Buildingonthenewregulatoryinfrastructure,thestresstestswillbringtogetherexpertisefromacrosstheBank,includingmacroeconomists,financialstabilityexpertsandsupervisors. ThiswillmateriallystrengthentheBank’sanalyticalcapability to assessrisksto resilience. Ourintentionisthatstresstestingevolvesintoanessentialcomponentofourprudentialframework,complementingour capitalandliquiditystandards. ThispaperhasbeenproducedbystaffattheBankundertheguidanceoftheFPCandthePRABoard. Itspurposeistogeneratediscussion abouttheappropriatedesignofthestress-testingframework inthemediumterm. AssetoutintheExecutiveSummaryandelsewhere,theBankisactivelyseekingto elicitfeedbackontheproposalsfromabroadrangeofstakeholders. Welookforwardtoreceivingyourresponses. October2013 InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  13. P age |13 Aframeworkforstress testingtheUKbankingsystemExecutivesummary The FinancialPolicyCommittee(FPC)recommendedinMarch2013that,‘lookingto 2014andbeyond,theBankandPrudentialRegulationAuthority(PRA)shoulddevelopproposalsforregularstresstestingoftheUKbankingsystem. Thepurposeofthose tests wouldbetoassessthesystem’s capitaladequacy’. ThisDiscussionPaper—producedbystaffattheBankofEnglandundertheguidanceoftheFPCandthePRABoard—setsoutthemainfeaturesoftheproposedstress-testingframework. Itsaimis to elicitfeedbackfrominterestedparties tohelpinformFPCandPRABoarddecisionsovertheultimatedesignofthestresstests. Themainpurposeofthestress-testingframeworkistoprovideaquantitative,forward-lookingassessmentofthe capitaladequacyoftheUKbankingsystemandindividual institutionswithinit. ItaimstosupportboththeFPCandthePRAinmeetingtheirstatutoryobjectives. Tofacilitateassessmentofthesystemasawhole,stresstestswillbecarriedoutconcurrentlyacrossthebanks,buildingsocietiesand PRA-designatedinvestmentfirms(henceforthreferredto as‘banks’)thatare inscope. Theannualstresstestswilldeliveranintegratedprocessfordeliberationsaroundbankcapitaladequacy,bothatasystem-wideandan individual-institutionlevel. AndtheywillprovideadevicethroughwhichtheBankcanbeheldaccountabletoParliament,andthewiderpublic,onitsfinancialstabilityobjective,byallowingtheFPCandthePRABoard to articulatetheresiliencestandardagainstwhichtheyholdthebankingsystem. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  14. P age |14 Regularstresstestsshouldalsobolsterpublicconfidenceinthestabilityofthesystem,bydemonstratingtherangeofsevere,butplausible,stressesthatauthoritiesexpectbankstobeabletowithstand. Itisenvisagedthat—overthemediumterm—thestresstestsproposedinthisDiscussionPaperwillcoverthemajorUKbanksandsignificantUKsubsidiariesofforeignglobalsystemicallyimportantbanks. TheDiscussionPaperalsoconsidersthemeritsofincludingmedium-sizedUKbanks withinthisframework. Anditnotesthat,giventheirimportancetofinancialstability,theBankisalsoconsideringthemeritsofaseparateconcurrentstress-testingregimeforcentralcounterparties. UndertheframeworkproposedinthisDiscussionPaper,stresstestswouldexplorearangeofscenarios, including: (a)commonscenariosappliedacrossallbankstakingpartintheexercise —thesewouldbedesignedbytheFPC,in consultationwiththePRABoard;and (b)bespokescenarios,designedbyindividualbanksandapprovedbythePRABoard. Thebespoke scenariosare intendedtoexploreriskstowhicheachbankwouldbemostvulnerable. In part,thisisbecauseakeyaimofthestress-testingframeworkistostrengthenbanks’owncapabilitiestoidentifyandquantifyriskstotheirbusinesses. Thebespoke scenarioswouldbeexpected to resultinhigherlossesforthebanks inquestionthanthecommonstressscenariodesignedbytheFPC. TheBankexpectsthatthestress-testingframeworkwilluseasuiteofmodels to translatethesescenariosintoprojectionsofbankprofitability andcapitalratios. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  15. P age |15 Thiswill involvemodellingbyBankstaffaswellasbyindividualbanksthemselves. Thisapproachseekstoguardagainsttheriskthatthestresstestbecomesexcessivelyexposedtotheunavoidableweaknessesofanysinglemodel. Italsoseeks to mitigatetherisksassociatedwithexcessiverelianceon banks’ownmodelling:banksmayfaceincentives tobeoverly optimisticabouttheimpactofstressscenariosontheir capitalpositionto achieveamorefavourableresultinthestresstest. Butthesuiteofmodelsdoesleaveagreaterroleforjudgementincombiningmodeloutputstoreachanoverallviewon capitaladequacy. Overtime,Bankstaffwillalsoseektoenhancethewayinwhichvariousfeedbacks andamplificationmechanisms—forexamplebetweenthebankingsystemandthewidereconomyorbetweenindividualbanks— arecapturedaspartoftheBank’sanalysis. Thesearelikelytohaveacrucialbearingonsystem-wideresilience. Bankstaff,underguidancefromtheFPCandthePRABoard,willsynthesisetheoutputsofthesemodelstoformasingle,overallviewabout theperformanceofthesystemandindividualbanksin eachscenario. Interpretingtheseresults,andreachingajudgementaroundcapitaladequacy,willrequireaviewonthelevelofcapitalthatregulatorswantbanks tomaintaininthefaceofsuchlosses. Thisisultimatelyapolicydecisionby theFPCandthePRABoard,accordingtotheirrespectiveresponsibilities. Attheveryleast,banks wouldneed tomaintainsufficientcapitalto beable to absorblossesin thestressscenarioandnotfall below internationallyagreedminimumstandards. Butthelevelofcapitalthatbankswouldneed tomaintaininthestressscenariocouldbeset abovestrictinternationallyagreedminimaandvary acrossbanks. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  16. P age |16 In addition,thestresstestswillproducearangeofotherinformationthatisexpected to informFPCandPRABoardjudgements. Thiswillincludeaqualitativeassessmentofbanks’ ownstress-testingandcapitalmanagementprocessesandgovernance. Itisimportantthatcrediblepolicyactionsaretakenin responsetotheresultsofthestresstests. Tothisend,theresultsofthestress-testingexerciseareexpected tobeusedto: informtheFPC’sassessmentoftheresilienceofthefinancialsystemand,indoingso,aidformulationofpolicyresponses;and supportPRABoarddecisionsandactionsonindividualbanks,takingintoaccountanysystem-wide actionsbytheFPC. Crucially,theresultsofthestresstestsarenotexpected tobemechanicallylinkedtopolicyresponses. Thisisnotintendedtobeasimple‘pass-fail’regime. Rather,itaimstodeliveramoregraduatedpolicy framework, wherethemagnitudeofremedialactionstakenwouldbeafunctionofpolicymakers’judgementaroundtheadequacyofbanks’capitalplans. Forexample,ifthestresstestsrevealedthatindividualbanks—orthesystemasawhole—fell below internationallyagreedminimainthestressscenarios,thiscouldpointtomaterialinadequaciesintheircapitalisation. In turn,thiswouldlikelyresultinthePRArequiringmaterialremedialactionstostrengthen capitallevels. Requiredremedialactionswouldlikelybesmallerifstresstestsrevealedthatbanksremainedaboveinternationallyagreedminima,butstillbelowtheappropriatelevelofpost-stresscapitaldeterminedbytheFPCandthePRABoard. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  17. P age |17 Bankscouldalsoberequiredtotakeremedialactionsinlightofidentifiedinadequaciesintheirstress-testingandcapitalmanagementcapabilities,evenifthePRABoardjudgedthattheywereadequatelycapitalised towithstandtherangeofscenariosexploredaspartofthestress test. Akeyprincipleunderpinningtheproposedframeworkisthattheoutcomeof,andanalysisassociatedwith,theannualstresstestsshould bemadepublic. Transparencyovermethodologiesadopted,stress-testresultsaswellaspolicy andsupervisoryresponsesby theFPCandthePRABoardwillsupportthecredibilityoftheframework,facilitateaccountabilityofpolicyinterventionsandincentivisebanks to engagefullywiththeexercise. TheBankwouldwelcomecommentsfrominterestedpartiesonallaspectsofthispaper. AmorespecificlistofquestionsonwhichtheBankwouldparticularlywelcomefeedbackissetoutattheendofthisDiscussionPaper. Commentsshouldbesentby10January2014to: VasileiosMadourosBankofEnglandThreadneedleStreetLondon,EC2R8AH Orbyemailto:stresstestingdp@bankofengland.co.uk. 1Introduction The FinancialPolicyCommittee(FPC)recommendedinMarch2013that,‘lookingto 2014andbeyond,theBankandPrudentialRegulationAuthority(PRA)shoulddevelopproposalsforregularstresstestingoftheUKbankingsystem. Thepurposeofthose tests wouldbetoassessthesystem’s capitaladequacy’. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  18. P age |18 AtitsJune2013meeting,theFPCdiscussedasetofprinciplesthatwouldinformthedesignofthestress-testingframeworkinthemediumterm,asummaryofwhichisprovidedinBox1. ThisstaffDiscussionPaperdescribesthemainfeaturesoftheproposedframeworkforregularstresstestingoftheUKbankingsystem. BuildingtheBank’s capabilitiesto deliverthestress-testingframeworkoutlinedinthisDiscussionPaperwilltakeanumberofyears. The2014exercisewillbeasteppingstonetowardsthemedium-termframework. Assuch,itisexpectedtobemorelimitedin application(seeBox7). TheFPCandthePRABoardwillconsidertheprecisedesignofthe2014exerciseinmoredepthoverthecomingmonths. Thestress-testingframeworksetoutinthisDiscussionPaperwillprovideaquantitative,forward-lookingassessmentofthe capitaladequacyoftheUKbankingsystemandindividual institutionswithinit. Tofacilitateanalysisoftheresilienceofthesystemasawhole,stresstestswillbecarriedoutconcurrentlyacrossthebanks inscope. Thiswill deliveranintegratedframeworkfordeliberationsaroundbankcapitaladequacy,atbothsystem-wideandindividual-institutionlevel,bytheFPCandthePRABoard. ThestresstestswillalsoprovideadevicethroughwhichtheBank canbeheldaccountabletoParliament,andthewiderpublic,onitsfinancialstabilityobjective. Awell-understoodstress-testingframeworkallowstheFPCandthePRABoardtoarticulatetheresiliencestandardagainstwhichtheyhold thebankingsystem. Thiswillfacilitatethecommunicationofpolicy interventionsbytheFPCandthePRABoard. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  19. P age |19 • Itwillalsoimprovethepublic’sunderstandingoftherangeofsevere,butplausible,stressesthatauthoritieswantbanks tobeable towithstand,strengtheningpublicconfidenceinthebankingsystem. • ForthepurposesofthisDiscussionPaper,a‘stresstest’isdefinedastheevaluationoftheimpactofdifferentscenariosonthe capitalpositionof banksandthesystemasawhole. • Crucially,thestressscenariosshouldnotbeinterpretedasstatesoftheworldthattheFPCorthePRAperceiveaslikelytohappen. • Theycharacteriseseverebutplausibleshocks,whichtheauthoritiesexpectbanks tobeable to withstand to reducerisks to financialstability. • Similarly,stresstestingisnotaboutmechanisticallycalculatingpointestimatesofbankcapitalratiosinanadversescenario. • Rather,itisasetoftoolsthatallowspolicymakers to explorevulnerabilitiesofthebankingsystem,helpingtoidentifyinherentuncertaintiesaroundbankcapitaladequacy. • In developingthestress-testingframeworkproposedinthisDiscussion Paper,Bankstaffareseekingto incorporatethelessonsfromtheUnitedKingdom’spastexperiencewithsupervisoryandsystem-widestresstests. • Bankstaffhavealsodrawnontheextensiveinternationalexperiencewithstress testing,benefitingfromdiscussionswith—andinsightsof—therelevantauthorities(seeBox2). • ThisDiscussionPaperisissuedforpubliccommentandaims to elicitfeedbackfrominterestedparties. • Theprecisedesignofthefollowingfeaturesoftheframeworkislikely tobeparticularlyimportantindeliveringstressteststhatareperceivedascrediblebythemarketandareusefultopolicymakers: • Scenariodesign:Anystress-testingexercisewillonlybeascredibleas theadversescenariosthatarebeingconsidered. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  20. P age |20 TheBankexpects toexplorearangeofscenariosinanysingleexercise. Thiswillacttoreducetherisk thatthesystemasawholeisonlyresilienttoasingle‘badstateoftheworld’. Akeyaspectofscenariodesignistheextenttowhichthedegreeofseveritywouldvarythroughthecycle,toreflectthechangingprobabilityandimpactofasystemicstressmaterialising. Byassessingtheresilienceofthebankingsystemtoprogressivelymoreseverescenariosintheupswingofthecycle,stresstests caninformthesettingofcountercyclical policy. • Modellingapproaches:TheBankexpects touseasuiteofmodels toestimatetheimpactofstressscenarios. Thisapproachseeksto guardagainsttherisk thattheframeworkbecomesexcessivelyexposed totheunavoidableweaknessesofanysinglemodel. Italsoleavesagreaterroleforjudgementin combiningmodeloutputstoreachanoverallviewon capitaladequacy. Bankswillalsobeexpectedtodevelopandusetheirownmodelstojudgethelikelyimpactofstressscenarios. Infact,akeyaimoftheframeworkistostrengthenriskmanagementandmeasurementstandardswithinbanksthemselves. Theoutputsofthosemodels canbeusedasanadditionalinputintotheBank’soverallanalysisofbankcapitaladequacy. TheBankrecognisesthatindividualbanks mightseek to achieveamorefavourableoutcomeinthestresstestsbybeingoverlyoptimisticabout theimpactthatastressscenariowouldhaveontheircapitalposition. WhiletheBankexpectstobetakinganumberofsteps tomitigatethat risk,thereremainsachoice abouthow muchweightitisappropriatetoplaceontheoutputsofbanks’ownmodels. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  21. P age |21 • Disclosure:Akeyprincipleunderpinningthestress-testingframeworkisthattheoutcomeof,andanalysisassociatedwith,thestress-testingexercise shouldbemadepublic. • Buttherearebothbenefitsandcostsassociatedwithdisclosureofstress-testoutcomes. • TheDiscussionPapersetsoutdifferentoptionsforwhatinformation mightbedisclosed—andatwhatdegreeofgranularity—tofacilitateengagementofdifferentstakeholderswiththestress tests. • In consideringtheproposedstress-testingframeworksetoutinthisDiscussionPaper,itisalsoimportant tobeclearaboutthelimitationsofthis toolinservingtheneedsoftheFPCandthePRA. • Thestresstestsproposedhere,forexample,willonlyfocusonasubsetof bankswhoseactivitiesarejudgedmostlikelytoposeriskstoUKfinancialstability. • Smallerbanks arenotexpectedtobecoveredbythisframework(seebelowforotherPRAstress-testingrequirementsthatapplytoall • UK-regulatedbanks). • Moreover,theexercisewillfocusprimarilyonriskstobanksolvency. • Atleastinitially,fundingandliquidityvulnerabilitiesarelikelytobeincorporatedonlyasamplificationmechanisms. • Assuch,thestress-testingframeworkwillnotbethesoleprocessthroughwhichtheFPCandthePRABoardwillarticulatetheirassessmentof bankcapitaladequacy. • Theframeworkwillprovidethetwobodieswithanopportunity toundertakeanannual,in-depthassessmentofbanks’resiliencetodifferentstresses. • Butthisshouldnotbeinterpretedasanindicationthatsupervisoryactionsormacroprudentialpolicy decisionsaroundbankcapitalwillbemadeonlyaspartofthisprocess. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  22. P age |22 BoththeFPCandthePRAwillconsiderwhether interventionsare requiredtosupportbankcapitaladequacythroughouttheyear,inlightof newrelevantinformationandanalysis. AllPRA-regulatedbanks arealreadyrequired to carryoutstresstestsandscenarioanalysisaspartoftheirInternalCapitalAdequacyAssessmentProcess(ICAAP). ThePRAisproposingto maintainthisrequirementfollowingtheimplementationofCRDIVandisconsultingonadraftgeneralstresstestandscenarioanalysisruleaspartofitsconsultationonimplementingCRDIV. Thisrulewouldapply to allbanks,includingthosecoveredbytheproposedstress-testingframeworksetoutin thisDiscussionPaper. Itisexpectedthatabank’sparticipationintheconcurrentstresstestsproposedinthispaperwillreplacethestresstestingthatbanksarecurrentlyrequiredtoconduct to informthePRA’sCapitalPlanningBuffer. Butthisframeworkwillnotreplacetherequirementthatbanksundertakestress testsfortheirownriskmanagementpurposes. Inadditiontodomesticstresstests,anumberofbankswillcontinuetobesubjecttostresstestsco-ordinatedbyotherauthorities. Forexample,thelargestUKbankshavehistoricallybeenincludedintheEuropeanBankingAuthority(EBA)stresstestsandtheIMF’sFinancialSectorAssessmentProgram(FSAP)exercises. Andbanks withsignificantoperationsintheUnitedStateswilllikelybeincludedintheComprehensiveCapitalAnalysisand Review(CCAR)operatedbytheFederalReserve. Theseremainvaluableexercises,butservedifferentobjectivesandarelikelytobeconductedinadifferentwayfromthestresstestsdescribedinthispaper. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  23. P age |23 TheBankwillcontinuetoengagewithrelevantauthoritiesinternationally toconsiderhow thevariousinitiativesaroundstress testingcanbe co-ordinatedtominimiseanyunnecessarycostsofcomplianceforbanks. TheremainderofthisDiscussionPaperisstructuredasfollows. Section2setsoutthemain objectivesofthestress-testingframework. Sections3and4outlinekeyoperationalconsiderations,focusingonfrequencyandtimingaswellascoverageofinstitutions. Thesubsequentsectionsfocusonthe keyfeaturesoftheBank’sanalyticalapproachtostresstesting:scenariodesign(Section5),theuseofassetqualityreviews to informstresstests(Section6),modellingofstressscenarios(Section7)andtheuseofstress-testoutputstoassessbankcapitaladequacy(Section8). Section9coverstheremedialactionsthatcouldberequiredinresponsetotheresultsofthestresstestsandSection10exploresdifferentoptionsarounddisclosure. Finally,Section11setsouttheexpectationsthatthePRAislikely to havefrombanks inrelation tothisexercise. Giventheroleofthisframeworkininformingpolicy andsupervisoryjudgementsbytheFPCandthePRABoard,thePRAexpectsaclearstep-upinengagementbybankswiththestresstests—includingbytheirBoardsandseniormanagement. Section12outlinesasetofquestionsonwhichtheBank would particularlywelcomefeedbackfromrespondents tothisDiscussion Paper. Box1 PrinciplesforstresstestingtheUKbankingsystem Thisboxsummarises thekeyprinciplesthatareexpected toguidethedesignofthestress-testingframeworkinthemediumterm. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  24. P age |24 • ThesebuildontheprinciplesthatweresetoutbytheFPCintheJune2013FinancialStabilityReport. • Theyremainsubjectto adjustmentafterfurtheranalysisanddiscussion. • Indeed,akeyobjectiveofthisDiscussionPaperistoelicitfeedbackonthedevelopmentofthestress-testingframeworkbyinterestedparties. • Themainprinciplesunderpinningthedesignoftheframeworkare: • Purposeofthestresstests. • Themainpurposeofthestress-testingframeworkistoprovideaquantitative,forward-lookingassessmentofthe capitaladequacyoftheUKbankingsystemandindividual institutionswithinit. • In doingso,itwillinformFPCandPRABoardjudgementsaroundtheneedforpolicyandsupervisoryinterventions. • Frequencyofstresstests. • Itisenvisagedthatstresstestswillbeconductedonanannual basisandconcurrentlyacrossthebanks thatareinscope. • Coverageofthebankingsystem. • Theframeworkisexpected to coverthemajorUKbanks aswellassignificantUKsubsidiariesofforeignglobalsystemicallyimportantbanks. • Overtime,medium-sizedbanksmightalsobecoveredbytheframework, thoughsubjectedtoaproportionateversionoftheexercise. • Scenariodesign. • Foreachbank,arangeofscenarioswouldbeappliedaspartoftheexercise. • Thesewouldinclude: InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  25. P age |25 • commonscenarios,appliedacrossallbanks undertakingthestresstest,designedbytheFPC, in consultationwiththePRABoard; • bespokescenarios,designedbybanksthemselvesandapprovedby thePRABoard,withaseveritycalibratedto atleastmatchthecommonscenariosdesignedbytheFPC. • Applicationofscenarios. • AnalysisoftheimpactofscenariosonprofitabilityandcapitalratioswouldbeundertakenbyBankstaff. • Thiswoulduseasuiteofmodels. • Thescenarioswouldalsobemodelledbybanks themselves. • Theultimateoutputwouldbeasynthesisedviewofbanks’futurecapitalpositionsineachofthescenariosbeingconsidered. • Amplificationmechanisms. • Overtime,stress testingwillseek to capturetheeffectsofvariousfeedbacks andamplificationmechanisms. • Thesearelikelytohaveacrucialbearingonsystem-wideresilience. • Communication. • Disclosureoftheoutcomeof,andanalysisassociatedwith,thestresstestsshouldaimtosupport thecredibilityoftheframeworkandfacilitateaccountabilityofpolicy interventions. • Box2 • Internationalexperienceofstresstesting • Stress testinghaslongbeenestablishedasariskmanagementtoolbybanks. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  26. P age |26 Butsincetheonsetoftherecentfinancialcrisis,stresstesting has alsogrowninprominenceasakeymicroandmacroprudentialtool. NotableexamplesofregulatorystresstestsconductedduringthecrisisincludetheUSSupervisoryCapitalAssessmentProgram(SCAP) in2009andtheEU-widebankingsectorstresstestsin2009–11. Anumberofcountrieshavealsoputinplaceframeworksforregularstresstestingoftheirrespectivebankingsystems. In seekingtodrawlessonsforthedesignoftheUKframework,thisboxreviewstheinternationalexperiencewithstresstesting. Table1summarisestheapproachtakenbyselectedjurisdictions. Keyfeaturesofinternationalstress-testingregimes Mostjurisdictionscoversystemicallyimportantbanks:Regulatorystressteststypically coverasubsetofbanks withinajurisdiction—usually thosedeemedtobesystemicallyimportant. Someauthoritiesseekto capturealargernumberofbanks. But, inthose cases,stress teststendtobeusedlargelyasasurveillancetool,withtheresultsbeinglesscloselylinked to policy actions. TheUSauthoritiesalso coversomenon-bankfinancialcompanies,asrequiredundertheDodd-FrankAct. Themajorityofcountriesconductstresstestsonanannualbasis:Mostcountriesseebenefitsin conductingannualstress-testingexercisesthatareinlinewithbanks’regularcapitalplanningcycle. Othercountriesconductsemi-annualstresstests,theresultsofwhicharepublishedinFinancialStabilityReports. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  27. P age |27 Datarequirementsvaryacrossjurisdictions:Somecountries(suchasSweden)relyexclusivelyonpubliclyavailabledatatorunsupervisorystress tests. Othercountries(suchasIrelandandtheUnitedStates),requirebanks toprovidegranularloan-leveldataforthemajorityoftheirloan booksasaninputtotheirstress-testingprocesses. Mostcountriesuseasuiteofmodels:Asa minimum,allcountriesthathave adoptedBaselIIassessthequalityandresultsofbank-ledstresstestsaspartoftheInternalCapitalAdequacyAssessmentProcess(ICAAP). InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  28. P age |28 Inaddition,anumberofcountriesalsocarryoutregulator-ledstresstestsusinggranularmodelsofbanks’incomestatementitems. In theUnitedStates,forexample,authoritieshavepubliclystatedthat theyhave40in-housemodelstoprojectbanks’lossesandrevenues. Furthermore,agrowingnumberofauthoritieshavebeendevelopingtheirsystem-widestress-testingcapabilities. Mostjurisdictionsusearangeofscenarios:Regulatorsinternationallyrecognisetherisksassociatedwithrelyingonasinglestressscenarioandseektoincorporatearangeofadversescenariosaspartoftheirstresstests. Thereisagrowingemphasisonbank-designedscenarios,wherebanksareaskedtodesignscenariosmostrelevanttotheirbusinessmodel. Disclosureofstress-testingmethodsandresultsvariessubstantiallyacrossjurisdictions:Someauthoritieshavebeenveryopenaboutthemethodologiestheyemployandthescenariostheyuseandalsopublishverygranularbank-by-bankstress-testresults. Othershaveoptedtokeepaspectsoftheirstress-testingregimesprivate. Theuseofstress-testoutputsalsovariesacrosscountries:Somestresstests,suchas theUSSCAPandtheCCAR,aswellastheEuropeanBankingAuthority(EBA)exercisesinEurope,havedirectimplicationsforbanks’capitalplansanddistributions. Inmostcountries,theresultsofstress-testingexercisesareusedasoneofasetofinputsintopolicy decisionsaroundbankcapital. 2Purposeofstresstesting Themainpurposeofthisstress-testingframeworkis toprovideaquantitative,forward-lookingassessmentofthe capitaladequacyoftheUKbankingsystemandindividual institutionswithinit. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  29. P age |29 In doingso,itwillsupportboththeFPCandthePRAinmeetingtheirstatutoryobjectives. TheFPC’sprimaryobjectiveis toidentify,monitorandtakeactiontoremoveorreducesystemicrisks,withaviewtoprotectingandenhancingtheresilienceoftheUKfinancialsystem. Itssecondaryobjectiveistosupporttheeconomicpolicy oftheGovernment. ThePRAhasastatutoryobjectivetopromotethesafetyandsoundnessofthefirmsitregulates,withparticularfocusontheharmthatfirmscancause to thestabilityoftheUKfinancialsystem. Thestress-testingframeworkwillinformtheFPC’sjudgementontheresilienceoftheUKbankingsystemtopossiblefuturesystemicstresses. ItwillequiptheFPCwithanevidencebaseandaquantitativeapparatustoassesstheneedforpolicy interventions,givenemergingrisksor vulnerabilities. Assuch,itwill helptheFPCevaluatethebenefitsofanypolicyinterventionsdesignedtomitigatethoserisks. Thestress-testingframeworkwillalsoinformjudgementsofthePRABoardonthesafetyandsoundnessofindividual institutions. Itwillhelpthe PRABoardassesstheneedfor,andimpactof,supervisoryresponses,taking intoaccountanysystem-widepolicy actionsbytheFPC. Theresultsofthestresstestsarenotexpected tobemechanicallylinkedtosupervisoryresponsesbythe PRABoardorsystem-widepolicyactionsbytheFPC. ByinformingFPCandPRABoardjudgementsaroundbankcapitaladequacy,thestress-testingframeworkwillresultin: InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  30. P age |30 • Anintegrated,regularprocessfordecision-makingaroundbank • capitaladequacy. • Thestress-testingexercisewillcontribute to anintegratedframeworkfordeliberationsaroundcapitaladequacy,atbothsystem-wideandindividual-institutionlevel,bytheFPCandthePRABoard. • Thiswillprovidegreaterclaritytothemarketabouthowthesedecisionsaremade. • AdevicethroughwhichtheBankcanbeheldaccountabletoParliament,andthewiderpublic,onitsfinancialstabilityobjective. • Awell-understoodstress-testingframeworkoffersonetoolthroughwhichtheFPCandthePRABoardcanarticulatetheresiliencestandardagainstwhichtheyaimtoholdthesystem. • Thiswillfacilitatethecommunicationofpolicy interventionsbythetwopolicymakingbodies. • Astrengthenedsupervisoryapproach. • AsthePRAhasalreadysetout,aninherentfeatureofforward-lookingsupervisionisthat,attimes,thesupervisor’sjudgementwillbeatvariancewiththatofbanks. • Thisunderscorestheneedforsuchjudgements to bebasedonevidence.Astrengthenedstress-testingframeworkwillenhance thecredibilityofthesupervisoryapproachbyenrichingthebodyofevidencethatinformssupervisoryjudgementsandhelpingarticulatethosejudgementsmoreclearly. • Enhancedpublicconfidenceinthebankingsystem. • Acrediblestress-testingframeworkcanstrengthenpublicconfidenceinthestabilityofthebankingsystembydemonstratingtherangeofsevere,butplausible,stresseswhichauthoritiesaimtoensurethatbanks canwithstand. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  31. P age |31 • Improvedrisk andcapitalmanagementpracticeswithinbanks. • Theframeworkwillprovideonetoolthroughwhichauthoritiescanaimtoensurethatbanks areheldtohighstandardsintheareasofriskmanagementandcapitalplanning. • Whiletheprimarypurposeofthestress-testingframeworkisto informFPCandPRABoardjudgementsaroundbankcapitaladequacy,theframeworkshouldbeexpected todeliveranumberofadditionalregulatorybenefits. • Theseinclude: • Informingarangeofpossiblepolicy andsupervisoryinterventions. • Thequantitativetoolkitunderpinningthestress testswillbeable toinformjudgementsaroundarangeofpotentialinterventionsbytheFPCandthePRABoardthatmightextendbeyondbankcapitalrequirements(seeSection9). • Betteraccesstodatabyregulators. • Thestress-testingframeworkshouldimproveregulators’accesstohigh-qualitydataonrisk exposures,enhancingtheirunderstandingofbanks’businessmodelsandriskprofiles. • Itwillalsofacilitatemoremeaningfulandconsistentanalysisofrisksandvulnerabilitiesacross thebankingsystem. • Strengthenedmarketdiscipline. • Atransparentstress-testingframeworkshouldenhancemarketdiscipline,byenrichingmarketparticipants’informationsetaroundtheresilienceofindividualinstitutionsandthebankingsystemasawhole. • 3Frequencyandtimingofstress tests • Itisenvisagedthatthestresstestswillbeconductedonaregularbasisandconcurrentlyacrossthebanksthatarein scope. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  32. P age |32 Frequency Thestress-testingframeworkshouldaimtodeliveratimelyassessmentofcapitaladequacyforindividualinstitutionsandthebankingsystemasawhole. Banks’balancesheetcomposition,aswellasthenatureandmagnitudeoftheriskstowhichtheyareexposed,canvarysignificantlyovertime. Asaresult,longlagsbetweentheexerciseswouldbeundesirable. TheFPCandthePRABoardwillwanttorespondtopotentialthreatstostabilityinatimelymannerandthestress-testingframeworkisexpectedtobeakeyinputintotheirforward-lookingjudgementsaroundbankcapitaladequacy. Goingintheotherdirection,stresstestingataveryhighfrequencywouldentailmaterialresourcecosts,bothforbanks andregulators. Thiscouldcompromisethequalityoftheexercise. Forexample,itwouldrisk thestress-testingexercisebecomingan overlymechanicalprocess,squeezingoutinnovativethinkingaroundnew,emergingrisksorsufficientengagementbykeydecision-makers tointerpret—and actupon—theresults. In balancingtheseconsiderations,thestresstestsareexpectedtotakeplaceonanannualbasis. Thisisconsistentwithpracticesinothercountries,suchastheUnitedStates(seeBox 2),aswellasthePRA’sdraftsupervisorystatementonstress testingthatwaspublishedaspartoftheCRDIVConsultationPaper. Conductingsupervisorystresstestsonaregularbasisentailsanumberofadditionalbenefits. Itencouragesbanks—andtheauthorities—toinvestcontinuouslyintheirstress-testingcapabilities. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  33. P age |33 It can alsooperateasamechanismforguardingagainst‘riskillusion’,byforcingbothbanks andregulatorstothinkhardaboutthetypesofrisksthat canposethreatsto stability. Finally,conductingregularstress testingwouldavoidtheriskassociatedwithmarketparticipantsinterpretinganauthority-initiatedstresstestasanadversesignalaboutthehealthofthebankingsectororaparticularbank. Concurrency Theconcurrentnatureofthestress testsisakeyelementoftheproposedframework. Thereareanumberofbenefitstosuchanapproach. Crucially,fromamacroprudentialperspective,carryingoutthestresstestssimultaneouslyallowstheFPCtoassesstheresilienceofthesystemasawhole,ratherthanfocussolelyonindividualbanks. Forexample,aconcurrentexercise canhelptheFPCassessthebuild-up ofexposurestoaparticularsectoracrossthefinancialsystem. Anditallowsthe FPCtotakeintoaccountpotentialamplificationmechanismsthatcouldarisedue tothebankingsystem’sresponsetoanadverseshock(seeBox 4). Thesehavebeenimportantmechanismsofpropagationofinitialshocksinprevioussystemiccrises. Similarly,fromamicroprudentialperspective,thesimultaneousnatureoftheexercisewilldelivergreaterconsistency inthePRA’sapproachtosupervision. Forexample,theapplicationofcommonstressscenariosatagivenpointintimehelpsensurethatthePRAholdsbanksagainstthesameresiliencestandard. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  34. P age |34 • Finally,runningstresstestsconcurrentlycanhelpstrengthentheanalyticalrigouroftheexercise. • Theauthoritieswillbebetterplacedtochallengestress-testoutputsgeneratedbybanks,forexamplebycomparinglossratesonsimilarportfoliosacrossbanks,orbyincorporatinginsightsfromanalysisofcorporate,householdorothersectorsproducedfromanassessmentofthebankingsystemasawhole. • Theconcurrentnatureofthestresstestswillalsofacilitatebenchmarkingofbanks’ capitalmanagementandstress-testingprocesses. • Timing • Partoftheobjectiveofthestress-testingframeworkistoembedaclearandregularprocessforconducting in-depthanalysisthatinformsFPCandPRABoardjudgementsaroundbankcapitaladequacy. • Box3describestheexpectedannualstress-testingcycleinmoredetail. • Supervisoryactionsormacroprudentialpolicydecisionsaroundbankcapitaladequacywillstillbetakenoutsideofthisprocess,however,incorporatingarangeofrelevantinformationandanalysis. • TheBankexpectsthat—overthemediumterm—theresultsofthestress testsarelikelyto bepublished aboutsixorsevenmonthsafterthedateofthebalancesheetinformationusedasinputsfortheexercises. • ThisisbroadlyinlinewithcurrentpracticeintheUnitedStates,wheretheCCARstress teststakeapproximatelysixmonthsfromthedata • cut-offuntilpublication. • Thisseekstobalanceanumberofconsiderations,including: • Timeliness:Itisimportantthattheinputsused,suchasbalancesheetdata,remainrelevantbythetimethatstress-testoutputsareusedtoinformpolicymakers’judgement. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  35. P age |35 • Qualityofresults:Thereisoftenatrade-offbetweentimelinessand • qualityofthestress-testingexercise. • StaffattheBank,aswellasatfinancialinstitutions themselves,willneedtohavesufficienttime to ensurerigorousanalysisandinterpretationofthestress-testresults. • Seniorstaffengagement:ItiscrucialthatBoardsandseniormanagementofthebanksbeingstresstestedengagecloselywiththisexercise.Theannualcycleshouldallowsufficienttimeforthemtodoso. • Governanceandreviewissues:Internalgovernancerequirementsandreviewperiodslimithowquicklythestress testscantakeplace. • Also,forbankswithEuropeanoperations,remedialactionsmayneed tobediscussedbyinternationalcollegesofsupervisorsaspartoftheEU’sJointRisk AssessmentandDecisionprocess,withpotentialimplicationsforthelengthandtimingoftheannualcycle. • Interactionbetweenbanksandregulators:Theexercisewillinvolveaperiodofengagementbetweenthebanksandtheregulators. • Forexample,bankswillbeexpected toexplainandjustifykeyjudgementstakenin theirownmodellingoftheimpactofstressscenarios. • Theannualcycleshouldallow sufficienttimeforsuchinteractions. • Whileitisimportantthatthereisagreementaboutfacts,suchasbalancesheetdata,stress-testoutcomesarenot theresultofanegotiation betweenbanks andregulators. • In consideringtheannualstress-testingcycle,akeyconsiderationwillbetheprecisedateforthebalancesheetinformationusedfortheexercise. • Thedateofbanks’annualaccountswouldbeanaturalstarting point. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  36. P age |36 Annualaccountshavetheadvantageofbeingexternallyauditedandthiswouldalsoallowinvestorstoassessstress-testresultsagainstinformationthattheyarealreadyfamiliarwith. Butnotallbanks usethesamereportingdatefortheirannualaccounts,soitwouldnotbepossible to applythisapproachuniformly. Aimingtouseannualaccountsmightalsoputadditionalstrainsonbanks’resourcesatanalreadybusyperiodoftheyear. Thisisanarea wheretheBankwouldwelcomefeedbackfromrespondentstothisDiscussionPaper. Box3 Adescriptionoftheannualstress-testingcycle Thisboxoutlinesthekeystagesoftheannualstress-testingcycle. Thesearepresented in broadlychronologicalorder,butsomemaybehappeningconcurrently. Theboxalsoprovidesabroadindicationofthetimethatwouldbeallocatedtoeachstageoftheprocess. Thisassumesthatresultsofthestresstestswouldbepublished aboutsix–sevenmonthsafterthedateofthebalancesheetinformationusedasinputsforthestresstests. Some aspectsofthetimingswilldifferforthe2014exercise,whichisexpectedtotakeplaceoveralongertimescale(seeBox7). (1)Designcommonscenarios(approximatelytwelveweeks) TheFPC,liaisingwiththePRABoard,willdesignthecommonscenariosfortheforthcominground. Thescenarioswillthenbereleasedtobanks.Itisexpectedthatthedatacut-offwillbeatapproximatelythesametimeasthisrelease. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  37. P age |37 Banks’scenariodesign(approximatelytwelveweeks) In ordertorunthecommonscenariosusingtheir ownmodels,banksarelikelytohavetoextendthenumberofvariablesprovidedbytheBank. Individualbankswillalsolikelyberequiredtodesigntheirown,bespoke,scenariosasdiscussedinSections5and11. Bankswouldbeexpected todomuchofthiswork—forexample,identifyingtherisksthatthebespokescenarioswillarticulate—in parallelwiththedesignofthecommonscenariosbytheFPC. Giventheexpectationthatthebank-specific scenariosshouldbemoreseverethanthecommonscenarios,bankswillhaveafurthermonthtocalibratetheir ownscenariosaftertheyreceivethecommonscenarios. BankswillberequiredtosubmitthebespokescenariosforreviewtothePRA. Independentstress-testinganalysis(approximatelytwelveweeks) StaffattheBankaswellasindividualbanks themselveswillconductthestress-testinganalysisusingthescenariosthathavebeendeveloped. Bankswillalsoneedto identifyrealisticmanagementactionsthatcould betakentoimprovetheircapitaladequacy. Seniorstaffatthebanks shouldbecloselyengagedwithbothaspectsofthisworkandareexpected to beresponsibleforsign-offoftheresultsbeforesubmittingthem tothePRA. Analysisofstress-testresultsandPRAchallengeofbankresults(approximatelytwelveweeks) Bankstaffwillsynthesisetheoutputsacrossthesuiteofmodelstoformasingle,overallviewaboutbanks’performanceineachscenario. ThePRAwillbeinclosediscussionwiththebanksthroughoutthisstage,queryingandchallengingthebanks’ ownresultswhereappropriate. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  38. P age |38 FPCandPRABoardreviewresultsandagreepolicy actions(approximatelyfourweeks) Thestress-testresultswillbeconsideredbytheFPCandthePRABoard. Thetwobodieswillusethis to informtheirjudgementsaroundbankcapitaladequacyatthesystem-wideandinstitution-specificlevel. ThePRABoardwillalsomakeaqualitativeassessmentofbanks’ stress-testingand capitalplanningprocesses,andassesstheadequacyofbanks’ capitalplanstodeterminewhethertheyaresufficienttomeettheoveralllevelofcapitalisationdeterminedbytheFPCandthePRABoard. Publicationofoutcomes TheFPCandPRAwillcommunicatetheoutcomeofthestresstests. 4Coverageofinstitutions Thestress-testingframeworkoutlinedinthisDiscussionPaperisexpectedtofocusonthosebankswhoseactivitiesarejudgedmostlikelytoposerisks to UKfinancialstability. Aimingforcoverageofallinstitutionsinthefinancialsystemwouldbeunnecessarilycostly,withsmallmarginal benefitsfrompolicymakers’perspectivebeyondacertainpoint. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  39. P age |39 • Principlesfordeterminingthecoverageofstresstests • TherearethreemainconsiderationsthattheBankexpectswillinformthedecision to includeinstitutionsinthestress-testingexerciseoverthemediumterm. • Institutions’importancetoUKfinancialstability:FinancialstabilityisatthecoreofthestatutoryobjectivesofboththeFPCandthePRA.Soinstitutions’importancetoUKfinancialstabilityisakeyconsiderationindeterminingtheirinclusioninthisstress-testingframework. • FPCandPRApowerstorequireremedialactions:InstitutionswouldonlybeincludedifthepowersoftheFPCandthePRAallowedthemtotakeappropriateactionsinformedbythestress-testresults. • Banks’legalandregulatorystatusintheUnitedKingdomthereforebecomesakeyconsiderationdeterminingcoverage. • Broadcomparabilitybetweeninstitutions:Manyofthebenefitsfromincludingfinancialinstitutionsinaconcurrentstress testarelikelytoariseonlywhentheiractivitiesaresufficientlysimilartothoseofotherfirmscoveredbytheexercise. • Additionally,includinganoverlydiverserangeofinstitutions,eachrequiringseparateanalyticaltoolkits,wouldriskmakingtheframeworkexcessivelycomplexto implementandcommunicate. • Implicationsoftheseconsiderationsforthecoverageofconcurrentstresstests • Basedontheseconsiderations,theBankenvisagesthatthestress-testingframeworkwillincludethemajorUKbanks(seeTableAforarankingofUKbanks by totalassets). • TheBankexpectsthisgrouptoincludetheeightbanksthatwerethefocusoftheFPC’sandPRA’srecent capitalshortfallexercise(BarclaysGroup,TheCo-operativeBankplc,HSBCHoldingsGroup,Lloyds InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  40. P age |40 BankingGroup,NationwideBuildingSociety,RoyalBankofScotlandGroup,SantanderUKplcandStandardCharteredBankGroup). Adisorderlyfailureofanyoftheseinstitutions,individually,couldposematerialthreatstofinancialstabilityintheUnitedKingdom. TheBankwillalsobeconsideringhow theprincipalUK-regulatedsoloentitieswithinthesefinancialgroupswillbetreatedaspartoftheexercise. TheBankisalsoconsideringthemeritsofincludingmedium-sizedUKbanksintheconcurrentstresstests. Oneoptionwouldbe to includetheseintheframeworkbutconductthestresstestsinawaythatisproportionatetotheirscaleandcomplexity,aswellasprevailingrisks to stability. This wouldbeconsistentwiththePRA’sduty tohaveregardtotheneedtominimiseanyadverseeffectsoncompetition,inthisinstancethroughthepotentialburdentheexercisewouldplace onbanks. Forexample,medium-sizedbanks couldbeexemptedfromrunningsomescenariosthatarelessrelevanttotheirbusinessmodels;oranalysismightfocusmostlyonspecificportfolios,withlessdetailontherestofthebalancesheet. Anotheroptionwouldbetoexemptmedium-sizedbanksfromtheconcurrentstress testsasamatterofcourse,butretaintheflexibilitytochangethescopeoftheconcurrentstresstestsatcertainpointsintime,dependingontherisks beingexploredbytheFPCandthePRABoardinagivenyear. TheBank’sstartingpositionisthat —overtime—medium-sizedbanksshouldbeincludedinthesteady-stateconcurrentstresstests, in aproportionatefashion. In part,thiswillhelpdeliveraconsistentapproach to supervision,ensuringthatahighproportionoftheUKbankingsystemisheld tothesamestandardsofresilience. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  41. P age |41 TheregulatorybenefitsofincludingsmallUKbanks,whenconsideredindividually,areunlikely to justifythecosts.SotheBankproposesthatthesearenotincludedintheconcurrentstresstestsoutlinedin thisDiscussionPaper. Buthistoricalexperience—forexampletheUKSecondaryBankingcrisisofthe1970sandtheUSSavingsandLoancrisisinthe1980s— suggeststhatthecollectivefailureofsmallerbankshasthepotentialtoposethreatstostability. Asaresult,itwillbeimportantfortheFPCtomonitorthebuild-upofcommonvulnerabilitiesacrossthebankingsystemasawhole,includingthosestemmingfromsmallerUKbanks. Morebroadly,allUK-regulatedbanksarerequiredtoruntheirownstresstestsaspartofexistingregulatoryrequirements.ThePRAisproposingtomaintainthisrequirementfollowingtheimplementationofCRDIV. TheBankenvisagesthatsignificantUKsubsidiariesofforeignglobalsystemicallyimportantbanksarelikelytobeincludedintheframework. Theseinstitutions(typicallyinvestmentfirms)areimportantforthefunctioningofUKfinancialmarketsandthecontinuityinprovisionoffinancialservices totherealeconomy. ButitisunlikelythatUKbranchesofforeignbankswouldbeincludedintheframework. Branchesarenotdistinct legalentitieswithseparate capitalresources. ForUKbranchesofEEAbanks,thePRA’spowersandresponsibilitiesarelimitedunderEuropeanlaw. ForUKbranchesofnon-EEAbanks,wherethehomeregimeisconsideredequivalenttothatoftheUnitedKingdomandwherethePRAhasassureditselfoverresolutionplansandthehomeregulator’ssupervisoryapproach,thePRArelies—wherepossible—onsupervisionbythehomeregulator. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  42. P age |42 Finally,itisnotenvisagedthatothertypesoffinancialinstitutionswillbeincludedaspartofthisstress-testingframework. Themodellingapproachnecessarytoanalysenon-banks,andthekeyriskdriversforthoseinstitutions,canbemateriallydifferentrelativetothoseforbanks. Forexample,thetypesofrisksfacedbyinsurancecompanies—whomthePRAalreadyrequirestoconductstresstests—canbeverydifferent,includinglongevityrisk forannuityprovidersorclaimsvolatilityfor non-life insurers. Moreover,thetypesofpolicy actionsthatanystress testswouldsupportarealsolikelytodiffer. But,aspartoftheFPC’sregularsurveillanceand,potentially,asaninputintothisframework,itwillbeimportantforthestress teststotakeaccountofrisksstemmingfrom,orpropagatingthrough,partsofthefinancialsectornotincludedwithinthescopeofthisexercise. Onewaythatthiscouldbe achieved isthroughscenariodesign. Morebroadly,theBankwillbemindfulofthepossibilitythatcertain investmentfirmscurrentlyregulatedbytheFinancialConductAuthority(FCA)might,atsomepointinthefuture,warrantinclusionintheproposedframework. AlthoughtheBankisnotcurrentlyproposingtoconductconcurrentstresstestsforinsurersalongsidethoseforthebankingsystem,feedbackfromrespondentsonhow theBankmightbestincorporate theresultsofthestresstestsitalreadyconductsforinsurersintotheframeworkforbanksoutlinedinthisDiscussionPaperwouldbewelcome. In addition,giventheirimportanceforfinancialstability,theBankwillseparatelyconsidertheneedforastress-testingregimeforcentralcounterparties(CCPs)operatingintheUnitedKingdom. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  43. P age |43 Asafirststep,theBankwillbeundertakingathematicreviewoftheadequacyofUKCCPs’ internalstress-testingpracticesduring2014andwillreportconclusions totheFPC. Buildingonthat,theBankwillconsiderthemeritsofdevelopingaseparateregimeforconcurrent,cross-CCPstress testingthatcouldcomplementtheframeworkforbanksoutlinedinthisDiscussionPaper. ThiscouldstrengthentheBank’ssystem-wideanalysis,forexamplebysheddinglightontheimpactofhighermargincallsonthesystem. TheBankwouldwelcomefeedbackfromrespondentsonthemeritsofaconcurrentstress-testingregimeforCCPs,tocomplement,andpotentiallyinform,thatforbanks. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  44. P age |44 5Scenariodesign Therearethreekeyelementsthatdeterminetheoverallanalyticalapproachtostresstesting: Thedesignofscenarios Theapproachtomodellingtheimpactofscenariosonprojectedbankprofitabilityand capitalratios Contingentonthoseoutputs,thestandardsagainstwhichbanksareassessed to reachaviewon capitaladequacy. Thissectionoutlines theBanks’proposedapproachtoscenariodesign.The othertwo aspectsareconsideredinSections7and8respectively. Thereisalsoaread-acrossbetweenthelossesexpected to occur inabaselinescenarioandassetqualityreviews. Theselinks areconsideredinSection6. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  45. P age |45 • AkeyprincipleunderlyingtheBank’sapproachto stress testingis toexplorearangeofscenarios. • Anysinglescenarioisalmostcertainnottomaterialise. • Anditisnotdesirablefromaregulatoryperspectivethatthebankingsystemasawholeisonlyassessedagainstasingle‘badstateoftheworld’. • Moreover,fromapracticalperspective,differencesinbanks’businessmodelsimplythatscenariosthatmightbestressfulforonebankmightbemuchlesssoforanother. • Tomaketheframeworkusefulforpolicymakers,stresstestsshouldexploredifferentvulnerabilitiesandmanifestationsofpossiblefuturestresses. • Overall,theframeworkislikely to incorporatethreebroadsetsofscenarios: • AsetofcommonstressscenariosdesignedbytheFPC,inconsultationwiththePRABoard,andappliedacrossallbanksundertakingthestresstest. • Asetofbespokestressscenariosdesignedbyindividualbanks,andapprovedbythePRABoard,withadegreeofseveritycalibratedtomatchatleastthatofthecommonstressscenariosdesignedbytheFPC. • AcommonbaselinescenariodesignedbytheFPCandinformedby,amongotherthings,theMPC’sforecastsascommunicatedintheBank’sInflationReport. • Thestresstestswouldformallybeapplied to individualbanksundertheauthorityofthePRA,conductedbystafffromacrosstheBankandreportedbacktotheFPC. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  46. P age |46 • Approachtothedesignofcommonstressscenarios • Theseverityofthestressscenariosisakeydeterminantofthe overallresiliencestandardtowhichthebankingsystemisbeing heldbytheauthoritiesthroughthestress-testingexercise. • Thestressesbeingassumedneedtobebothsufficientlysevere,butalsoplausible. • Crucially,thestressesshouldnotbeinterpretedasstatesoftheworldthat theFPCorthePRAperceiveaslikelytohappen. • Akeyconsiderationwhendesigningscenariosistheextenttowhichtheseverityofthescenariosbeingexploredmightvaryacrossstresstestsconductedatdifferentpointsintime. • Anexplicitlycountercyclicalapproachtoscenariodesignwouldrecognisethevariationintheprobabilityandimpactofsystemicstressesovertime. • Forexample,ascreditconditionseaseandleveragebuildsup,thebankingsystemmaybesusceptibletomoresevereshocks. • Conversely,in adownturn,withtighteningcreditconditionsandlowerleverage,alessseverescenariomightbemoreappropriate,dependingontheparticularcircumstances. • In practice,twobroadapproachesmaybetakenwithrespecttohowtheseverityofagivenscenariorelatestoeconomicandfinancialconditions: • Oneoptionwouldbetoaimforabroaddegreeofconsistencyintheseverityoftheshocksapplied. • Forexample,assetpricesmightbeassumedtofallbysomepercentagerelativetothebaselineprojection,irrespectiveoftheircurrentlevel. • Similarly,thestressscenariomightassumeagivenpercentagepointincreaseintheunemploymentraterelative to thebaselineprojection,regardlessofthecurrentunemploymentrate. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  47. P age |47 • Suchanapproachcouldallow theauthoritiestoidentifyhowchangesinbanks’risk-takingbehaviour(suchaslooseninginloanunderwritingstandardsovertime)mightincreasetheirvulnerabilitytoabroadlystablesetofshocks. • And,inadownturn,itwouldensurethatthescenariosresultinsufficientlystressfuloutcomes. • Atthesametime,suchanapproachmightamplifyprocyclicalityinthefinancialsector,withthestressscenarioeffectivelybecominglesssevereinanupturn(whenprofitsandassetvaluationsarehigh)andviceversainadownturn. • Analternativeapproachmightbetovarytheseverityoftheshocksappliedintheadversescenario,dependingonprevailingeconomicandfinancialconditions. • Forexample,assetpricescouldbeassumedtofallrelativetosomelong-runequilibriumlevel. • Duringperiodswhen,forexample,housepriceswereabovethatlevel,the sizeoftheshockinthestressscenariowouldbelarger. • Similarly,theunemploymentratecouldincreasetoagivenlevelinthestressscenario. • Thiswouldmeanthat,atpointsintimewhenunemploymentislow,theincreaseintheunemploymentrateinthestressscenariowouldbelarger. • Theseverityoftheshockscouldbefurtheramendedtoreflectthestateofcreditmarkets— forexample,tohelpcaptureamplificationmechanismsbetweenthefinancialsystemandtherealeconomy(seeBox4). • Themainadvantageofsuchanapproachisthatitwouldseektoreflecthow systemicriskchangesovertime,reducingprocyclicalityin thesystem. • Butitwouldalsorequirejudgementsbypolicymakersonthestateofeconomicandfinancialconditionswhendesigningscenarios. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  48. P age |48 • Forthemedium-termframework,theBankisconsideringtwo possibleapproachestothedesignofthecommonscenarioswithinagiven exercise: • Thefirstwouldbetoemployasinglecommonstressscenario. • Thiswouldstartfroma‘base’methodology,aimingatabroadlyconstantdegreeofseverity acrossstresstestsconductedatdifferentpointsinthecycle. • TheFPCwouldthenoverlayjudgements to increaseorreducetheseverityofcertainshocksovertime,factoring initsviewsaroundtheprobabilityorimpactofsystemicrisksinthedesignofscenarios. • Thesejudgementswouldlikelybeinformed,atleastinpart,bytheFPC’ssetofcoreindicators. • Whilesimpleroperationally,theuseofasinglecommonscenariowouldcomeatthecostofareducedsetofinformationtoallow theFPCandthePRABoard to informtheirrespectivepolicy andsupervisorytools. • Analternativeapproachwouldbetousetwocommonstressscenarios:onethataimsatabroadlyconstantdegreeofseverityacrossstress tests,independentofeconomicandfinancialconditions;andonethatseeks totakeintoaccountprevailingconditionswhencalibratingscenarioseverity,includingthelevelsofleverage,debtandcreditgrowth. • Suchaframeworkwouldallow theFPCtoexploreparticularvulnerabilitiesthatmightbeamplifiedbythestateofthefinancialsystemandthewidereconomyatthetime. • AnditwouldfacilitatetheuseoftheoutputsofstressteststoinformthesettingoftherespectivetoolsoftheFPCandthePRABoard. • TheBank’sapproachtothedesignofthecommonstressscenariosisalsolikelytoincorporatethefollowingprinciples: InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  49. P age |49 • Scenarioswillseektoallow theFPCandthePRAtoexploretheimpactofpotentialtippingpointsthatmightleadtosharpchangesintheimpactofstressscenarios. • Forexample,iftheeconomy-widedistributionofborrowersissuchthatrepaymentdifficultieswouldincreasesharplybeyondacertainlevelofinterestrates,thedesignofscenarioswouldseek to incorporatethatinformationto ensurethatbanks’businessmodelsaresufficientlystressed. • Whilesomedegreeofconsistencyofscenarioseverityovertimemightbedesirable,theframeworkwillneedtobeflexibleenoughtoallowtheFPCandthePRAtoexploredifferentsourcesofsystemicrisk,asthesearelikelytochangeovertime. • In consideringtheriskstobeexploredaspartofthestress-testingexercise,theFPCandPRAwilldrawonrisk assessmentanalysisfromacrosstheBank. • ThisiscarriedoutbystaffintheFinancialStability,MonetaryAnalysisandSupervisoryareasoftheBank. • Thescenariodesignprocesswillalsoseektoincorporatemarketviewsofkeyrisks—forexample,byemployinginsightsfromtheBank’sSystemicRisk SurveyanditsMarketIntelligencefunction. • Synthesisoftheseinsightsalreadytakesplace—forexample,duringtheproductionoftheFinancialStabilityReport(FSR). RiskshighlightedintheFSRareparticularlylikelytobeconsideredaspartofscenariodesign. • Fromanoperationalperspective,thecommonstressscenariosareexpectedtoincorporatebothmacroeconomicandmarketshocks. • TheBankexpectstospecifypathsforkeyvariables,suchasGDPgrowth,unemployment, interestrates,houseprices,etc. • ThescenariosarelikelytocoverUKvariablesand,dependingonthepreciserisksbeingexploredbytheFPCandthePRAatthetime,possiblyalsoforeignvariables. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  50. P age |50 ArangeofmodelsaswellashistoricalexperiencewillhelpinformthederivationofvariablepathsbyBankstaff. Butfutureepisodesofstresswillalmostcertainlybedifferentfromthosepreviouslyobserved,forexampleduetofinancialinnovationandchangesinmarketstructures. Sothescenariosmightincludeshockstoriskfactors,theprecisenatureofwhichmaynothavebeenpreviouslyobserved.Overall,therefore,therewillbearoleforjudgementindesigningthestressscenarios. Thedurationofscenarioswillbeconsistentwiththerisksthattheyhavebeendesignedtoexplore. Forexample,scenariosdescribingmacroeconomicoutcomeswould tendtobearoundthreetofiveyearsinduration,whereassuddenandsevereevents,suchasmarketshocks,wouldoccuroverconsiderablyshorterhorizons. In practice,adversescenariosarelikelytoincludeacombinationoftheseelements. TheBankexpects tobeprovidingfurtherdetailsofitsapproachtodesigningcommonstressscenariosin futurepublications. Approachtothedesignofbank-specificscenarios Allbanksthattakepartin theconcurrentstresstestsproposedinthisDiscussionPaperarelikelytobeexpectedtodesign,andassesstheimpactof,abespokestressscenario. Banks,liaisingwithPRAstaff,wouldbeexpectedtodevelopscenariosthataremorecloselyalignedtotheirparticularbusinessmodels. Supervisoryinsightsmaybeusedtoidentifybank-specificvulnerabilities —forexample,originatingfromparticularexposurestocertainbusinesslinesorregions. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

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