The Assignment
A mid-level investing bank needed to implement a stress testing framework in accordance with guidelines issued by the central bank.
Our mandate was to develop a collaborative, auditable, repeatable, and transparent stress testing program to meet regulatory expectations, inform on the bank’s risk appetite framework, and improve strategic business decisions.
Our Solution
The solution included the following key features:
1. Stress testing
Our stress testing framework comprised of regular stress tests and scenario analysis with severe macroeconomic global downturn scenarios. We included all material risk types into our stress testing exercises which included portfolio- and country-specific stress tests.
2. ICAAP
Capital plan stress testing was performed to assess the viability of the capital plan in adverse circumstances and to demonstrate a clear link between risk appetite, business strategy, capital plan and stress testing.
3. Scenario Analysis
The stress test framework also consisted of defined macroeconomic downturn scenarios which were based on quantitative models and expert judgments, economic parameters such as foreign exchange rates, interest rates, GDP growth or unemployment rates.
4. Reverse Stress Testing
Reverse stress test were to be performed annually in order to determine the severity of scenarios that would cause the bank to become unviable.
5. Risk Reporting and Measurement
The stress testing framework supported regulatory reporting and external disclosures, as well as internal management reporting, to be presented to senior management as well as to the risk committees, who are responsible for risk and capital management.
Key Takeaways for the Client
A robust stress testing framework that integrated governance, documentation, data quality management, economic scenario development, loss modeling, forecasting, and reporting and incorporated participation of all stakeholders across business units.
The framework was integrated across asset classes and lines of business and enhanced risk management and was customized to the unique strategies and risks of the bank’s portfolio
INTERNATIONAL PARTNERS
NEW YORK & INDIA
How we implemented the Internal Capital Adequacy Assessment Process (ICAAP) for our client
The Assignment
One of our clients, a medium-sized investment bank was required to implement an ICAAP (Internal Capital Adequacy Assessment Process), as a part of Pillar 2 within the Basel II Framework. The implementation of the ICAAP, which represents a bank’s own assessment of the capital needed to run the business, was a regulatory requirement mandated by the country’s central bank
Our Solution
As a part of our ICAAP implementation we helped the client bank to put in place internal policies, procedures and processes that ensured that the bank possessed adequate capital resources in the long term to cover all of its material risks.
Under the Internal Capital Adequacy and Assessment Process (ICAAP) we developed internal models for the bank to assess, quantify and stress test risk drivers and factors and the amount of capital required to support them.
In addition to credit, market and operational risks, the ICAAP also included risks that are not formally subjected to the minimum regulatory capital (e.g. liquidity risk, reputational risk, business risk or interest rate risk in the banking book) and different methodologies were used to price in these risks. This resulted in a more comprehensive pricing system that covered expected and unexpected losses, and assisted in better evaluation of the adequacy of capital in relation to the bank's overall risk profile.
One important component of the Internal Capital Adequacy and Assessment Process (ICAAP) was stress testing of all risk factors in order to arrive at the capital requirements for the worst case scenario. Our stress testing scenarios allowed the bank to plan and prepare for unexpected situations that may arise in the future. These stress tests were applied to credit, market, operational and liquidity risks.
Key Takeaways for the Client
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Awareness of potential weaknesses in the financial risk management strategy, frameworks and processes as well as in the risk mitigation to avoid unexpected or surprising losses.
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Implementation of risk management framework consistent with the bank’s financial risk strategy and risk appetite.
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Implementation of processes and methods for ICAAP and economic capital management consistent with bank’s risk management framework.
Allocation and attribution of risk capital to all significant sources of risk, stress test results and information to the board of expected or projected capital shortfall.