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Comprehensive Balance Sheet Stress Testing

 

Stress testing of balance sheet exposures has long been a prudent risk management practice at financial services firms. Despite spanning several risk dimensions, including credit risk, interest rate risk (“IRR”) and liquidity risk, the recent financial crisis revealed weaknesses in the scope, use and integration of stress testing practices. In considering how to address these and other weaknesses in the financial system, Congress passed the Dodd-Frank Wall Stress Reform and Consumer Protection Act (“DFA”) in July 2010; this act (as well as several subsequent regulatory pronouncements) codified specific requirements for formal stress testing activities, including which macroeconomic scenarios are to be analyzed, which methodologies are to be used, the integration of risk factors, how modeling assumptions are to be set, comprehensive results reporting as well as clarifying expectations for governance and use.
Most organizations found that they were not prepared to meet the heightened stress testing standards. In general, risk management functions were not integrated and factor-specific analysis was not combinable in any meaningful way. Exacerbating this challenge, most vended balance sheet modeling solutions were not designed to address the new modeling requirements. In short, ALM models were unable to dynamically model credit risk and credit risk systems did not address the rest of the balance sheet and did not typically have dynamic simulation capabilities. Neither of these systems was integrated with a fully-specified macroeconomic scenario generator and neither addressed data deficiencies which were endemic. As a result, multiple systems were patched together to compute an assessment of capital adequacy, but close review of model output usually revealed the need for significant qualitative adjustments to model projections. These were due to a combination of weak models, inadequate or poor quality data and weak integration of balance sheet and income statement risk impacts. Best practices confirms that the granular and consistent application of stress scenarios across current and forecast business activities and positions is a prerequisite for producing results that are accurate, transparent and useful in the management of balance sheet risk.

 


Location:
 Downtown Conference Center, New York, United States of America
Country:
  United States
Start Date:
 Oct 13, 2014
End Date:
 Oct 14, 2014
Organizer:
 N/A
Sectors:
 Business & Finance
 
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