OSFI.Stress Flashcards
Provide the general definition of stress-testing
Stress testing is a risk management technique to evaluate effects on financial condition due to specified changes in risk factors corresponding to exceptional but plausible events
Provide a quick summary of the 4 purposes of stress-testing
- Risk Identification and Control
- Complement:
- Provide a complement to other risk management tools + simulate shocks - Capital Management:
- Support capital management - Liquidity Management:
- Improve liquidity management
Describe - risk identification and risk control (regarding purpose of stress-testing)
Stress testing should be used to address institution-wide risks, and consider the concentrations and interactions between risks in stress environments that might otherwise be overlooked
Risk identification:
- Identify concentrations & interactions of risks
Risk control:
- Adjust individual portfolios & overall business strategy
Describe - complementing other tools (regarding purpose of stress-testing)
Stress tests should complement risk quantification methodologies that are based on complex, quantitative models using backward looking data and estimated statistical relationships
- Test statistical methods used to determine VaR
- Simulate shocks to test model robustness to economic changes
Describe - Supporting capital management (regarding purpose of stress-testing)
Stress testing should form an integral part of institutions’ internal capital management where rigorous, forward looking stress testing can Identify severe events and/or compounding events that impact capital requirements/the institution
Describe - improving liquidity management (regarding purpose of stress-testing)
For assessing the institution’s liquidity profile and the adequacy of liquidity buffers in case of both institution-specific and market-wide stress events
Describe how stress-testing is a key risk management tool for a new coverage that the insurer is offering
Stress testing can help identify considerations and interactions between risks (then provide example relating to specific new coverage)
Describe board versus management responsibilities regarding a stress-testing program (3,3)
Board of Director’s responsibilities:
- Ultimate responsibility for program
- Ensures implementation of program by management
- Should be aware of key findings
Management’s responsibilities:
- Responsible for implementation, management & oversight of stress-testing program
- Must participate in the review and identification of potential stress scenarios
- Contributing to development & implementation of risk mitigation strategies
General Considerations for stress-testing programs (4)
- RANGE (range of perspectives, techniques)
- Stress testing program should cover a range of perspective and technique. Should consider views from across the company. - UPDATES (update stress-testing framework regularly)
- Management and board should regularly review and update its stress testing process as part of overall risk management. Effectiveness of stress-testing program & robustness of individual components should be assessed regularly & independently - DOCUMENTATION:
- The stress testing program should be governed by written policies, and operation to run the program should be appropriately documented. - INFRASTRUCTURE (should be flexible & robust)
- An institution should have a suitably robust infrastructure in place, which is sufficiently flexible to accomodate different and possibly changing stress tests at an appropriate level of granularity
Identify 3 considerations in scenario selection for stress-testing
Stress tests should cover a range of risks and business areas, as well as at the institution-wide level
Stress testing programs should apply accross business and product lines and cover a range of scenarios, including non-historical scenarios, and aim to take into account system-wide interactions and feedback effects
Stress tests should feature a range of severities, including events capable of generating the most damage, whether through size of loss or through loss of reputation
Identify 5 focus areas in response to financial turmoil and briefly describe each
- Risk Mitigation
- Stress Testing should facilitate the development of risk mitigation or contingency plans across a range of stressed conditions - Securitization & Warehousing
- The stress testing program should explicitly cover complex and customized products such as securitized exposures. The stress testing program should cover pipeline and warehousing risks. - Reputation (reputational risk)
- An institution should enhance it’s stress-testing methodologies to capture the effects of risks to reputation - Credit Risk (& Counter-Party Risk)
- An institution may have large gross exposures to leveraged counterparties - Concentration Risk
- Stress testing should consider risk concentrations resulting directly from risk taking activities as well as those resulting indirectly from actions to mitigate risks
Briefly describe 4 of OSFI’s considerations in assessing a stress-test program
- Evaluate whether scenarios chosen are consistent with the risk appetite the institution has set for itself.
- Assess whether scenarios are appropriate to the portfolio of the institution and that they include severe shocks and periods of severe and sustained downturn
- Assess whether the frequency and timing of stress testing is sufficient to support timely management action
- Ask institutions, from time to time, to carry out standardized:
- Sensitivity tests for individual businesses/products given evolving market conditions, or
- Scenario tests for use by OSFI to assess system wide vulnerabilities
Describe & contrast scenario with sensitivity testing
Scenario-Testing:
- Significant changes to risk factors
- Observe future state including ripple effects & management actions over a longer time horizon
- More complex and comprehensive
Sensitivity-Testing:
- Incremental changes to risk factors
- Shock is more immediate & time horizon is shorter
- Simpler & fewer resources required
