142. In addition to normal stress testing, each bank is expected to conduct reverse stress tests and document the process and outcomes of the process in the ICAAP report.
143. Banks are expected to apply a mix of qualitative analyses and quantitative analyses, which may vary in relation to the nature, scale, and complexity of the banks’ business activities and the risks associated with those activities. Accordingly, it may be acceptable for smaller and less complex banks to develop reverse stress tests that focus more on qualitative analyses, while larger and more banks that are complex should include more quantitative elements alongside the qualitative analyses. Appropriate scenarios differ based on each bank economic circumstances, business model and risk drivers.
144. A bank may consider implementing the following steps, which are presented purely for illustrative purposes:
| | | (i) | Define specific trigger points that could threaten the bank’s viability or solvency. Such trigger points may involve situations in which:
| • | The bank’s capital or liquidity positions fall below the minimum regulatory requirements;
| | • | Specific indicators which, if hit, reflect a loss of confidence by the bank’s counterparties (e.g. access to wholesale funding markets denied) or by depositors (e.g. deposit run-off rates reach a significant level); or
| | • | The bank is unable to repay its debt obligations. Some of the indicators may render the banks unviable (e.g. due to illiquidity resulting from a substantial and rapid deposit run) before it becomes insolvent.
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| | (ii) | Reverse-engineering the bank’s business model to the point that the trigger points are breached. In this way, it is possible to identify what adverse but plausible financial or non-financial events, either independently or combined, cause the bank to reach those trigger points notwithstanding existing management actions. That is, for reverse stress testing purposes, the bank is to tweak the parameters of a stress scenario until the point at which current systems and controls (e.g. accepted risk limits, controls, exposures and collaterals, etc.) are not able to prevent the bank from hitting the trigger point(s). The bank should understand the parameters and conditions in the scenario that precipitate a failed reverse stress test to analyse its risks and weaknesses. Feasible remedial actions should be designed that could prevent the consequences of such a scenario. For example, the bank could amend its business strategy regarding a specific sector.
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