VRM 8 - STRESS TESTING Flashcards
What is the rationale for the use of stress testing as a risk management tool?
To evaluate implications of extreme but plausible scenarios and ensure capital and liquidity adequacy.
What are key aspects of stress testing governance?
Choice of scenarios, regulatory specifications, model building, stress-testing coverage, capital and liquidity stress testing, reverse stress testing.
What is the relationship between stress testing and other risk measures?
Stress testing provides a detailed picture of risks when used alongside πππ and πΈπ in an enterprise-wide context.
Why are stressed inputs important in stressed πππ and stressed πΈπ?
They help assess risks based on how market variables behaved during significantly stressful periods.
What are the advantages of stressed risk metrics?
- Consideration of extreme scenarios
- Enhanced risk assessment capabilities
What are the disadvantages of stressed risk metrics?
- Potential overreliance on historical data
- Complexity in scenario development
What are key elements of effective governance over stress testing?
Clear policies, procedures, documentation, validation, independent review, and internal audit roles.
What responsibilities do the board of directors and senior management have in stress testing activities?
Overseeing stress testing governance, ensuring compliance, and integrating findings into decision-making.
What should comprehensive policies and procedures for stress testing include?
Clear definitions of stress testing processes, roles, documentation standards, and validation procedures.
What role does internal audit play in stress testing governance?
Ensures compliance with policies and procedures, and evaluates the effectiveness of stress testing activities.
What are the Basel stress testing principles for banks?
Guidelines for implementing stress testing to evaluate capital adequacy and risk management.
What is the definition of stress testing?
A risk management activity that evaluates the implications of extreme scenarios on financial institutions.
What scenarios are typically selected for stress testing?
Historical scenarios, ad hoc scenarios, and key variable changes.
What is an example of a historical scenario used in stress testing?
The 2007-2008 US housing-related recession.
How can a moderately adverse scenario be amplified for stress testing?
By multiplying the movements in all risk factors by a specific factor (e.g., double or triple the movements).
What is a key consideration when using historical scenarios?
Assuming relevant variables will behave as they did in the past may not hold true.
What is a short-horizon stress test?
A stress test assessing impacts from short periods of extreme market movements.
What are some key variables that can change in stress scenarios?
- Interest rates
- Volatilities
- Equity prices
- Unemployment rate
- GDP
What is the purpose of ad hoc stress tests?
To reflect current economic conditions and assess potential future adverse events.
What role do senior management and boards play in stress testing?
They should incorporate stress testing findings into decision-making processes.
What does regulatory stress testing require from banks?
To conduct specified stress tests including various scenarios and submit capital plans.
What is the Comprehensive Capital Analysis and Review (CCAR)?
A stress test for banks with consolidated assets over USD 50 billion, assessing their strength under various scenarios.
What scenarios do banks consider under CCAR?
- Baseline
- Adverse
- Severely adverse
- Internal scenario
What are core variables in stress testing?
Variables specified in the scenario definition affecting peripheral variables.
What is the knock-on effect in stress testing?
The impact of how firms respond to an adverse scenario, potentially exacerbating conditions.
What is reverse stress testing?
Identifying combinations of circumstances that could lead to the failure of a financial institution.
What is the difference between stress testing and πππ /πΈπ?
Stress testing is forward-looking and assesses extreme scenarios; πππ /πΈπ are backward-looking and based on historical data.
What is stressed πππ ?
A measure calculated using data from particularly stressful periods to assess potential future losses.
What time horizon does stress testing typically consider?
Longer periods, often assessing impacts over months to years.
What is the focus of stressed πΈπ?
To evaluate risk exposure based on historical stress periods and potential future scenarios.
What does stressed VaR represent?
Stressed VaR represents conditional risk measures based on historical data from particularly stressful periods.
It is a form of historical stress testing.
How does stress testing differ from traditional VaR measures?
Stress testing considers the impact of a whole year of adverse conditions, rather than just the worst days of a specific period.
For example, it might analyze a year like 2008 being repeated.
What are stressed inputs?
Stressed inputs are data from past periods when a company faced adverse conditions.
These inputs are crucial for calculating stressed VaR and stressed ES.
List some factors that can adversely affect a companyβs external environment.
- Major customer defaults
- Raw material price increases
- Withdrawal of credit lines
What is the importance of taking data from past adverse events?
It helps assess whether a company can survive similar conditions in the future.
Fill in the blank: A good example of stress factors for a company that exports furniture is if the exchange rate of INR to USD _______.
rises sharply
What are the key advantages of using stressed risk metrics?
- More conservative than traditional VaR and ES
- Forward-looking perspective
- Focus on longer time periods
What are the key disadvantages of using stressed risk metrics?
- Poor response to current market conditions
- Lack of probability distribution for losses
- Difficulty in backtesting
What role does governance play in stress testing?
Governance ensures that stress testing assumptions are thoughtfully considered and results are prudently acted upon.
What responsibilities does the board of directors have regarding stress testing?
- Overseeing key strategies
- Defining stress testing procedures
- Ensuring risk appetite and culture
What should senior management ensure regarding stress testing activities?
They should ensure activities are conducted by competent employees and reported periodically to the board.
What should written policies for stress testing include?
- Purpose of stress testing
- Procedures to follow
- Roles and responsibilities
- Frequency of testing
- Scenario building and selection procedures
True or False: Documentation of stress testing activities is often viewed as unimportant.
True
What is the role of independent review in stress testing governance?
To provide unbiased assurance that stress testing adheres to policies and considers necessary limitations and uncertainties.
What are the Basel stress-testing principles focused on?
- Providing forward-looking risk assessments
- Overcoming model limitations
- Supporting capital planning
- Informing risk tolerance
Why is the involvement of board and senior management important in stress testing?
Their involvement ensures effective setting of objectives, scenario definitions, and decision-making based on test results.
What shortcomings were identified in stress testing before the 2007-2008 crisis?
- Insufficient risk coverage
- Too mild scenarios
- Underestimation of correlations between risks
Fill in the blank: The Basel Committee published stress-testing principles for banks and their supervisors in _______.
2009
