STRESS TESTING

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Stress Testing
Presented to The Institute of Banking (IOB)
Riyadh, 23rd March 2011
Presented by: Syed Faraz Husain, Group Risk Management, NCB
Purpose and Use of Stress Testing
 Stress Tests are used to support the statistical tools such as Value-at-Risk (VaR) to gauge
the impact of the ‘tail risks’.
 Stress Tests are non-statistical tools where risk factors are stressed to assess their impact
on the bank. Hence, stress testing complements the VaR / Unexpected Loss
methodologies to assess the kind of losses that may occur if the markets are very
stressed and start behaving abnormally ('tail risk').
 Stress Tests are used by Senior Management and the Board to ensure that the Bank has
sufficient Capital to withstand such losses should they ever occur.
 Stress Tests serve as an input to test the Risk Appetite of the Bank – e.g. if any particular
risk is unwanted and, therefore, should be avoided
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Stressing Models vs. Scenario Analysis
Stressing Models
Scenario Analysis
Methods
Methods
o Push factor analysis – A factor or factors are
deliberately pushed to extreme and the
impact on the portfolio is measured
o Stylized Scenarios – based on industry
standards such as those defined by the
Derivatives Policy Group or by Regulators
o Maximum loss optimization - Identifies risk
factors that have the greatest potential
impact on the portfolio and moving to
protect against those factors
o Actual extreme events – uses past events
such as market crash of 1987, technology
bubble of 1990 etc.
o Worst Case scenario – All risk factors are
pushed to their worst cases
o Hypothetical events – that are based on
events that have not occurred but may
occur in future
Challenges
Challenges
o Incorrect inputs and assumptions and user
bias
o Inability to measure by-products of major
factor movements or include effects of
simultaneous adverse movements
o Inaccurately constructed risk models
o undue reliance on models
o User specification of the movements and
their correlations
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Developments in Stress Testing & Impact of 2008 Financial Crisis
 Stress Testing importance has been magnified
 Stress testing methodologies have been developed and formally documented as a policy
 In some cases results of past stress tests validated and in other areas assumptions used
have been revisited
 Results of stress tests are now being presented in a more comprehensive manner at the
entity level to the Senior Management and the Board
 Actions are being taken to manage risks highlighted through stress tests
 Results of Stress testing on capital are being presented and discussed with SAMA as
part of the ICAAP process
 SAMA endorsed the “Principles for sound stress testing practices and supervision”
issued by The Basel Committee on Banking Supervision in 2009
 Frequency of stress tests and reviewing underlying assumptions increased
Public disclosures could be mandated in future by International Financial Reporting
Standards or Regulators
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