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RiskMatrix

A how to guide for Stress Testing the ERM way

Ioannis Stamatopoulos, Director ERM Solutions RiskMatrix Ltd

November 2012

Agenda
Stress Testing Pre & Post Crisis:
Stress tests as early warning devices The Regulatory response lessons learnt

Key Elements of an integrated Stress Testing Framework:


Scenarios Data Models Deployment Platform

How we can help

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Stress Testing Pre and Post Crisis

RiskMatrix

Stress Tests as early warning devices

The banking systems reported financial indicators are above minimum regulatory requirements and stress tests suggest that the system is resilient.
IMF, Iceland: Financial Stability Assessment update, 19 August 2008.

Within two months, Icelands three biggest lenders had collapsed, leaving its economy in tatters.

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Regulators to the rescue

RiskMatrix

Stress Testing: Lessons learnt


Definition :

A stress test is commonly described as the evaluation of the financial position of a bank under a severe but plausible scenario to assist in decision making within the bank

The financial crisis has highlighted weaknesses in current stress testing practices. Use of stress testing and integration in risk governance Stress testing methodologies Scenario selection Stress testing of specific risks and products

Source: BIS, Principles for sound stress testing practices and supervision, 2009

RiskMatrix

Stress Testing In a nutshell

Senior Management Engagement

RiskMatrix

Key elements of an integrated Stress Testing Solution

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Stress Testing Programs require a range of scenarios and severities


Event-Driven Alternative Economic Scenarios

Sovereign Default Shock

Emerging Markets Hard Landing

In line with Regulatory Guidelines Baseline: Recession

S4: Severe Double Dip 1-in-25

S3: Double Dip 1-in-10

S2: Mild Double Dip 1-in-4

S1: Stronger Recovery 1-in-4

1:100

1:25

1:20

1:10

1:4

Forecast

1:4

Weaker Economy

Simulation-Based

Healthier Economy
9

RiskMatrix

10

accurate forecasts on the impact of these scenarios on the Macro Economy


Oil Prices under different alternative scenarios
180 160 140 120 100 80 60 40 20 0

Baseline Scenario Stronger Near-Term Rebound Scenario Mild Second Recession Scenario Deeper Second Recession Scenario Protracted Slump Scenario Below-trend Long-term Growth Scenario Oil Price Increase, Dollar Crash, Inflation Scenario

2010Q3

2015Q1

1994Q1

1994Q4

1995Q3

1996Q2

1997Q1

1997Q4

1998Q3

1999Q2

2000Q1

2000Q4

2001Q3

2002Q2

2003Q1

2003Q4

2004Q3

2005Q2

2006Q1

2006Q4

2007Q3

2008Q2

2009Q1

2009Q4

2011Q2

2012Q1

2012Q4

2013Q3

2014Q2

2015Q4

RiskMatrix

models to translate these scenarios into the key risk drivers


Performance data Delinquency Rates and/or CDRs Prepayment rate and/or CPRs Net Charge-off Rate Severity of Losses Econometric model

Output vectors Prepayments (CPR) Default (CDR) Severity (LGD)


All under alternative scenarios

Macroeconomic vectors Unemployment Rate, (Un)Employment Growth Average / Index House Prices Government interest rate and 10yrs bond rate Retail Sales Index Real GDP, Disposable Income, Private Consumption Total Debt Service Ratio

RiskMatrix

all integrated under the same roof


Data Analysis Tools Scenario Management Business strategy
(growth, risk appetite, target rating, M&A)

User Workflow

Economic/Regulatory scenarios
(MEDC, internal bank scenarios, FED)

Translation engines
PD & LGD models C&I Commercial RE SME Retail

Translation engines
Market data Interest rates Market prices Exchange rates Correlations

Translation engines
Balance sheet Contractual / Behavioral Amortizing / New volume Cost of funds Net interest income

Translation engines
Costs / Taxes Modeling Allocation

Liquidity ratios
Liquidity coverage Net stable funding ratio

P&L forecasts
Net interest income Costs Credit losses

Performance indicators
RAR / EVA RARORWA RAROC

Banks target rating


Global bank scorecard

Banks eligible capital


Common equity Dividends / Retained earnings Minority interests Sub debt maturing / Issuance Provisions / EL / Deductions

Regulatory capital
EAD (Behaviors / New volumes) Risk mitigation / Effective LGD RWA (EAD, PD, LGD) Countercyclical capital buffer

Economic capital
EAD (Behaviors / New volumes) Risk mitigation / Effective LGD EC (EAD, PD, LGD, Correlations)

RiskMatrix

How we can help

An integrated and open stress testing solution that goes well beyond software, leveraging on our economic expertise, financial and economic data repository and modeling services

RiskMatrix

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