OSFI Stress Testing

  1. Stress testing defined
    • risk management technique used to evaluate the potential effects on an institution’s financial condition, of a set of specified changes in risk factors
    • includes scenario testing and sensitivity testing
    • especially important after long periods of benign economic and financial conditions
  2. Purposes of stress testing
    • risk identification and control: address institution-wide risks
    • providing a complementary risk perspective to other risk management tools: allows for simulation of shocks which have not previously occurred, detect vulnerabilities, assess impact of customer behaviour
    • supporting capital management: identify severe events, impact of changes in market
    • improving liquidity management: identify, measure, control funding liquidity risk
  3. Role of Board of Directors
    • ultimate responsibility for overall program and should be aware of key findings
    • ensure that senior management has "fit for purpose" program in place
  4. Role of senior management
    • accountable for program’s implementation, management and oversight
    • should be able to identify and articulate risk appetite
    • must participate in review and identification of stress scenarios
  5. General conditions for stress testing programs
    • take account of views from across organization and cover a range of perspectives
    • documentation: written policies and procedures governing the stress testing program
    • suitably robust and flexible infrastructure in place to accommodate different and possibly changing stress tests at an appropriate level of granularity
    • regularly maintain and update stress testing framework
  6. Methodology and scenario selection
    • cover a range of risks and business areas; consistently cover product/business/entity views
    • apply across business and product lines; cover a range of scenarios, aim to account for system-wide interactions and feedback effects
    • feature a range of severities; determine scenarios challenging viability of institution
  7. Specific areas of focus
    • risk mitigation: reinsurance, hedging, netting; challenge performance of each
    • risk concentrations: credit counterparty, by region, correlated risk factors
    • risks to reputation: mitigate spill-over and maintain market confidence
    • securitization and warehousing risks: underlying assets, exposure to systemic factors
    • counterparty credit risk: hedge funds, investment banks; effect of severe market shock
  8. Supervisory consideration
    • evaluate whether scenarios chosen are consistent with risk appetite
    • assess whether scenarios are appropriate to portfolio and include severe shocks and periods of severe and sustained downturn; should include episode of market turbulence
    • assess whether frequency and timing of stress testing is sufficient for timely mgt action
    • ask institutions to carry out standardized sensitivity tests for individual products or scenario tests for use by OSFI to assess system wide vulnerabilities
    • examine future capital resources and capital requirements under adverse scenarios
    • take account of the extent to which capital might not be freely transferable
    • review range of mgt actions and understand rationale for mgt to take or not to take action
    • make recommendations to take appropriate remedial action to address weaknesses
Card Set
OSFI Stress Testing