1.A bank must have a forward looking stress testing program that addresses credit, market and operational risk with the bank taking into account that its risk profile is likely to require capital in excess of the minimum capital requirements. The stress testing program must also include any risk that is material for the bank given the nature of its business. These may include but are not limited to: concentration risk; interest rate risk in the banking book; liquidity risk; currency risk; reputation and compliance risks; contagion risk; country and transfer risks; legal risk; and strategic risk.
2.The requirement for a bank to use stress tests and scenario analysis to better understand potential risk exposures under a variety of adverse circumstances is common to both the risk governance framework and ICAAP. A bank must have a comprehensive approach to stress-testing that meets its ICAAP and other risk management requirements. Stress-testing within business lines can be a useful part of the program, however, there must be a means to capture correlations across business lines and obtain a bank-wide or, if applicable, a group-wide overview of performance in stress scenarios.
3.A bank’s stress-testing program must be undertaken on a regular basis to facilitate the tracking of trends over time and developments in key risk factors and exposure amounts, in addition to ad hoc stress tests as required. The program must cover a range of scenarios based on reasonable assumptions regarding dependencies and correlations. Senior management and, as applicable, the Board or board risk committee must review and approve the scenarios. The specifics of the program must be tailored to the risk exposures of the bank and, at a minimum, must take into account the following factors:
a.Bank and Group-specific and system-wide events;
b.Extreme but plausible shocks as well more gradual changes in key risk parameters such as interest and exchange rates;
c.Potential reputational risk implications of the bank’s actions in a stress scenario;
d.Potential for loss of key sources of funding; and
e.Potential outflows related to customer activity.
4.Stress test program results must be periodically reviewed by the Board or the board risk committee. Results must be incorporated into reviews of the risk appetite, the bank’s ICAAP and capital and liquidity planning processes. The risk management function is responsible for recommending any action required, for example adjustments to risk limits or contingency arrangements, based on stress test results. The results of stress tests and scenario analysis must be communicated to the relevant business line management and functional heads within the bank to assist them in understanding and mitigating the risks inherent in their activities. Stress test program results must factor in the bank’s contingency planning, particularly liquidity risk management and contingency funding.
5.The identification and management of all material risks must be consistent on a bank-wide and if applicable, group-wide basis. This is of particular importance with respect to a bank’s and, if applicable, a group’s ICAAP, given the significant intersection and mutual reinforcement of risk management and capital adequacy. For example, capital and liquidity implications need to be considered in the determination of risks the bank is prepared to assume and the limits for those risks established in the risk appetite statement. Similarly, the impact on capital and liquidity is an important element of a bank’s procedures for review of new products or business lines or acquisitions.
6.From the perspective of capital planning, the ICAAP must explicitly incorporate all material risks, which a bank identifies through its comprehensive approach to risk management. Stress test results must be considered in developing liquidity plans, particularly contingency funding arrangements.