• Document: Unified Stress Testing Framework Opportunities & challenges
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Unified Stress Testing Framework Opportunities & challenges Analytical contacts Ashok Subramanian Srinivasan Muthukrishnan Nageswara Sastry Ganduri Lead Analyst, Risk & Analytics Associate Director, Risk & Analytics Director, Risk & Analytics ashok.subramanian@crisil.com srinivasan.muthukrishnan@crisil.com nageswara.ganduri@crisil.com Table of contents Executive summary .............................................................................................................................................. 5 Stress testing: Introduction and regulatory comparison ..................................................................................... 6 Regulatory stress testing: The challenges ........................................................................................................... 9 The case for Unified Stress-Testing Framework .................................................................................................12 Unified Stress Testing Framework: Logical architecture....................................................................................13 Extensions to the Unified Stress Testing Framework .........................................................................................18 Concluding remarks ............................................................................................................................................18 References ..........................................................................................................................................................19 CRISIL as a Strategic Partner ..............................................................................................................................20 This page is intentionally left blank Executive summary Contrary to the common perception, stress testing as a financial risk management tool predates the global financial crisis and recession of 2007-2009. Even in the past, banks have had internal stress testing practices that helped them with risk budgeting, capital allocation and other management actions. However, after the global financial crisis, regulatory emphasis on, and the requirements for, stress testing started to increase dramatically. This led to a multiplicity of regulations with unique compliance nuances, which added various layers of complexity to the stress testing exercise. In this paper, we have comprehensively studied and analyzed requirements of three major global regulatory stress testing regimes - European Banking Authority (EBA) stress test, The Fed’s Comprehensive Capital Analysis and Review (CCAR) stress test, and Bank of England’s Prudential Regulatory Authority (PRA) concurrent stress test. We believe that by looking at regulations holistically and identifying commonalities, banks can achieve operational efficiencies and minimize their cost of compliance. In this paper, we demonstrate how commonalities across regulations lend themselves to the development of a Unified Stress Testing Framework. In our view, a robust stress testing program rests on four pillars: Scenario Input, Data, Analytics, and Reporting. In subsequent sections, we have drawn comparisons on how various regulatory and internal stress testing mandates fit within these pillars. A Unified Stress Testing Framework will be an architecture integrating these four pillars. Implementation of such a framework would pose unique challenges and requires innovative strategies. As a use case, we propose a logical architecture for the market risk case which can be further extended to enterprise wide stress testing framework. In addition, risk weights for different risk buckets defined in standardized approach of FRTB and risk weights in UMR/SIMM can technically be parallels to shocks in Stress testing. Similarly, many of the components of a unified framework can be reused or extended to other regulatory risk regimes and risk calculations thereby paving the way for an integrated risk framework. Unified stress-testing framework Scenario input Data Analytics Reporting Internal stress scenarios (historical, forward-looking, asset/business-specific) Regulatory stress scenarios (CCAR, EBA, PRA, MAS, FNMA) 5 Stress testing: Introduction and regulatory comparison The objective of stress testing is to assess the resilience of banks to severe, but plausible, market conditions. The scenarios considered could be historical or even hypothetical. After the global financial crisis of 2008, there has been increased regulatory scrutiny in this area. Multiple regulatory requirements and stringent deadlines pose challenges to banks, which are subject to both regular quantitative and qualitative assessments from regulators. For this discussion, we focus on three key regulatory stress tests: (1) The European B

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