STRESS TESTING CASE STUDY
• The process of stress testing is
designed to determine the viability of
an institution’s capital plan, which will
be used to ensure future capital
adequacy.
• That forward capital adequacy is
primarily a function of four factors:
 expected net losses
 pre-provision net revenue
 the net change in reserves
 Size of RWAs.
STRESS TESTING CASE STUDY
In teams you are to consider from the perspective of a supervisor what to look
for in the approaches taken by banks to assess their capital resilience
STRESS TESTING CASE STUDY
 Consider the importance of Scenario
selection – i.e. relevance to the
circumstances and vulnerabilities of
the group
 Consider also how robust the
selection process is in terms of
running multiple interconnected
scenarios in order to identify the
cumulative impact
US Economy
European
EMEA
Other
STRESS TESTING CASE STUDY
 Consider the
importance of selecting
a sufficiently severe but
plausible tests in order
to deliver a credible
and robust outcome
8
CONSIDER THE ADEQUACY OF THE OUTCOMES IN THE FOLLOWING EXAMPLE OF A CREDIT STRESS TEST
Example A: The regulatory provisioning requirement under a stress situation is assumed as 1% for all
The regulatory
provisioning requirement under a stress situation is assumed as 1% for all Standard (S); 25% for
Standard (S); 25% for Substandard (SS), and 100% for all Doubtful categories.
Substandard (SS), and 100% for all Doubtful categories.
Rs. Crore
Normal
situation
Asset Classification
S
Rate of
Provisioning (%)
Stress situation *
Exposure
Provision
1
900
9.00
SS
10
40
D1
20
10
D2
30
D3
100
Profit
Revised rate of
provi-sioning (%)
1.00
9.00
4.00
25
10.00
2.00
100
10.00
15
4.50
100
15.00
35
35.00
100
35.00
1000
54.50
18
Addl. Provisions
Impact on profits
(%)
ROA
Capital funds
RWA
CRAR
Provision
79.00
-6.50
24.50
-136.11
1.80
-0.65
95
70.50
954.50
930.00
9.95
7.58
* Assumed capital funds – Rs. 95 crore
Note:
1. Profit under stress situation = 18 – 24.50 = (-) 6.50
2. Capital funds under stress situation = 95 – 24.50 = 70.50
3. RWA under normal situation = 1000 – (4.00+2.00+4.50+35.00) = 954.50
4. RWA under stress situation = 1000 – (10.00 + 10.00 + 15.00 + 35.00) = 930
8
CONSIDER NOW THE ALTERNATIVE APPROACH TAKEN HERE :
The downgrade
fromregulatory
Standard to NPA
(sub standard)
is assumed to be
10% (i.e.,
the extent
of presentislevel
of gross NPAs)
and the
Example
A: The
provisioning
requirement
under
a stress
situation
assumed
as 1%
for all
provisioning
under stress situation
assumed
in example
A above:
Standard
(S);requirements
25% for Substandard
(SS), are
and
100%as
for
all Doubtful
categories.
Rs. Crore
Normal
situation
Asset Classification
S
Rate of
Provisioning (%)
Stress situation *
Exposure
Provision
Revised rate of
provi-sioning (%)
Provision
1
900
9.00
1.00
9.00
SS
10
40
4.00
25
10.00
D1
20
10
2.00
100
10.00
D2
30
15
4.50
100
15.00
D3
100
35
35.00
100
35.00
1000
54.50
Profit
18
Addl. Provisions
Impact on profits
(%)
ROA
Capital funds
RWA
CRAR
79.00
-6.50
24.50
-136.11
1.80
-0.65
95
70.50
954.50
930.00
9.95
7.58
* Assumed capital funds – Rs. 95 crore
Note:
1.
Profit under stress situation = 18 – 24.50 = (-) 6.50
2.
Capital funds under stress situation = 95 – 24.50 = 70.50
3.
RWA under normal situation = 1000 – (4.00+2.00+4.50+35.00) = 954.50
4.
RWA under stress situation = 1000 – (10.00 + 10.00 + 15.00 + 35.00) = 930
STRESS TESTING CASE STUDY
 Consider the transmission process by which the stresses from scenarios are “crunched”
through the accounting and/or modelling engines of the bank
 Consider (a) how senior management use the outcomes of stress tests to adjust their
business plans/strategies and (b) how the outcomes compare with the supervisory
macro-prudential stress tests