As such, stress testing should be prominent among the risk assessment tools used where these specific risks are material.
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Stress testing should facilitate the development of risk mitigation or contingency plans across a range of stressed conditions. The performance of risk mitigating techniques, like reinsurance, hedging, netting and the use of collateral, should be challenged and assessed systematically under stressed conditions when markets may not be fully functioning and multiple institutions simultaneously could be pursuing similar risk mitigating strategies.
Stress testing should also reflect constraints on management action and should not place undue reliance on the timeliness of mitigating actions. The stress testing program should explicitly cover complex and customized products such as securitized exposures. Stress tests for securitized assets should consider the underlying assets, their exposure to systemic market factors, relevant contractual arrangements and embedded triggers, and the impact of leverage, particularly as it relates to the subordination level in the issue structure.
The stress testing program should cover pipeline and warehousing risks. These are market, credit and funding risks arising in the period prior to securitization or sale and which may arise from the need to hold assets for longer periods than originally planned when markets are disrupted. An institution should include such exposures in its stress tests regardless of their probability of being securitized. Many of the risks associated with pipeline and warehoused exposures emerge when an institution is unable to access the securitization or other markets due to either institution specific or market stresses.
An institution should enhance its stress testing methodologies to capture the effect of risks to reputation. To mitigate reputational spill-over effects and maintain market confidence, an institution should have an approach to assess the impact of risks to reputation on other risk types. The institution should integrate risks arising from off-balance sheet vehicles and other related entities in its stress testing program. An institution should carefully assess the risks associated with commitments to off-balance sheet vehicles related to structured credit securities and the possibility that assets will need to be taken on balance sheet for reputational reasons.
Therefore, in its stress testing program, an institution should include scenarios assessing the size and soundness of such vehicles relative to its own financial, liquidity and regulatory capital positions. This analysis should include structural, solvency, liquidity and other risk issues, including the effects of covenants and triggers. An institution may have large gross exposures to leveraged counterparties, including hedge funds, financial guarantors, investment banks and derivatives counterparties that may be particularly exposed to specific asset types and market movements.
Performance Testing
Under normal conditions, these exposures are typically completely secured by posted collateral and continuous re-margining agreements yielding zero or very small net exposures. In the case of severe market shocks, however, these exposures may increase abruptly. The potential cross-correlation of the creditworthiness of derivative counterparties with the risks of the reference assets may emerge i.
An institution should ensure that its stress testing approaches related to derivative counterparties are robust in their capture of such correlated tail risks. Stress testing should consider risk concentrations resulting directly from risk taking activities as well as those resulting indirectly from actions to mitigate risks, e. In addition, concentrations may arise based on correlated risk factors that reflect subtler or more situation-specific factors, such as previously undetected correlations between market and credit risks, as well as between those risks and liquidity risk.
From time to time, OSFI may conduct an analysis of the impact of system-wide stress scenarios. OSFI intends as much as possible to test the impact of these system-wide scenarios using information that is reported in regulatory returns or regularly collected as part of the supervisory review process in order to minimize data calls on institutions. This will normally involve changes in a number of risk factors, as well as ripple effects that are other impacts that follow logically from these changes and related management and regulatory actions.
Scenario testing is typically conducted over the time horizon appropriate for the business and risks being tested.
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Sensitivity testing typically involves an incremental change in a risk factor or a limited number of risk factors. It is typically conducted over a shorter time horizon, for example an instantaneous shock.
Sensitivity testing requires fewer resources than scenario testing and can be used as a simpler technique for assessing the impact of a change in risks when a quick response or when more frequent results are needed. Return to footnote 1 referrer.
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Return to footnote 2 referrer. You may be trying to access this site from a secured browser on the server. Please enable scripts and reload this page. Skip to main content Skip to secondary menu. Comments including inappropriate will also be removed. By: Barbara Zigah With investor focus returning to the Eurozone and the results of bank stress tests which will be released later today, the U. Barbara Zigah. Also on DailyForex. Did you like what you read?
Let us know what you think! Your Name. Bank management actions to shore up buffers such as new capital issuances or capital injections from parent bank s ; and. Bank Negara said while banks can be expected to be more cautious given continued uncertainties and prospects of a more protracted recovery, it is in the collective interest of the banking industry to continue supporting viable businesses and households throughout this period.
Further, such buffers are vital for banks to remain resilient and reduce risk aversion. Banking 12h ago AmBank assesses goodwill for impairment value.
Fed to proceed with 2021 bank stress tests
Banking 31 Mar Bank Negara relaxes forex policies. Banking 1d ago Credit costs expected to begin normalising in H2. Article type: metered. Topic: Banking Economy. Did you find this article insightful? Related News.
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