“Stress Testing is here to stay”
On Tuesday 29th September, Asset Control’s VP Product Management Martijn Groot joined stress testing heads from a variety of banks, including BNP Paribas, Morgan Stanley, Barclays, UBS, Credit Suisse, Santander, for Stress Testing Europe 2015.
Taking place at London’s The Tower Hotel, under the rather spectacular shadow of Tower Bridge, CFP Events’ 3rd annual Stress Testing Europe event brought together almost 150 of the industry’s top players to discuss strategies, share ideas and formulate plans for the future.
Stress testing has truly come into its own as an independent discipline in the last 5 years, moving on from “a couple of paragraphs in the Basel framework”. Where 5 years ago a bank may have had a stress testing team made up of 4 or 5 people, to deal with incoming regulation-based scenarios – such as the FSA anchor 1 scenario – in today’s environment this would now be up to 100 or more at the major G-SIBs in Europe.
Though it has been a gradual inception, it still takes institutions by surprise how much time is required to stay apace of regulation and stress testing requirements. This is before you even take into consideration the intent behind the regulation; to embed stress testing in an institution’s mentality and ultimately have it become part of everyday business planning and ‘what if’ risk analysis.
Stress testing may now be firmly entrenched as an element of risk management, but it is also no longer limited to risk. It now takes in Treasury and Finance, for which many institutions have overlapping organisational frameworks. The quest? To develop an intuitive narrative of severe yet plausible future scenarios in granular detail to test a bank’s ability to cope in any given situation.
The challenge after creating and implementing these scenarios is to have one integrated view of them all, as one large assessment; being thoroughly prepared for the future.
Overcoming the Challenges of Reporting and Submitting Under Different Jurisdictions
Martijn’s panel discussion, alongside Cecilia Gejke, Executive Director, Liquidity Risk & Stress Testing at Mizuho Securities, and chaired by Ian Wilson of Deloitte, addressed ‘Overcoming the Challenges of Reporting and Submitting Under Different Jurisdictions’. This focused on how banks are dealing with the multitudinous regulations around the world, making specific reference to Mizuho’s need to report for European, US and Japanese regulators; all in different ways and with different inputs.
There is generally no synergy between regulators, meaning those involved in risk and stress testing become ‘mini IT project managers’ themselves in order to take on the various tasks involved, with an aim of achieving strategic solutions, often with people far away, with language differences.
Data aggregation and reporting
With regard to data aggregation and reporting, banks often spend a huge amount of time simply avoiding and correcting errors in Excel, such as automatic rounding. For regulations such as BCBS 239, data quality and infrastructure is paramount and therefore finding and correcting errors may be an onerous task, but an essential one.
As Cecilia alluded to in the discussion, consolidation into one central data warehouse is key, though developing this to envelope both input and output is not always possible; input is the most important to initially ‘slice and dice’, with output delineation often taking a back seat due to time and manpower restrictions.
Despite the resource constraints that still engulf many banks’ stress testing departments, developing scenarios that can be aligned across an enterprise is seen as a logical step for the future. At present, however, it is a case of “trying your best”, with the linking of shocks, augmenting and interpolating variables proving immensely time consuming.
The parameters for models are not currently clearly defined, which leaves banks with a lot – potentially too much – freedom to model as they wish. This freedom could make it easy for banks to tweak models, which could prove dangerous – highlighting the integral need for verification, for clear governance and for cascaded clarity around the purpose and meaning of the models.
With the rules around stress testing still being open to interpretation, clear, transparent communication across hierarchies and geographies is vital, as banks have to be able to make decisions of their own accord; and stand by these decisions if questions arise. Achieving this is possible through creating ‘working groups’ to manifest collaboration between teams, in particular the overlap of risk and finance. Each team and individual must understand their own limitations, while investing time in open dialogue – but this is a challenge to maintain, at all levels.
The need for a central data layer
Best practice says you should have a central data layer which branches out into different scenarios, through construction, timing, mapping and workflow. The scenarios should be run past Front Office operations early on, to assist with research and strategy. Though this can prove a large workload, it improves stakeholder engagement and governance and gets all teams on board.
Recent events in China have only served to reinforce the importance of stress testing as not simply a lot of separate forecasts but as dynamic, scalable scenarios as potential responses to future stress. As delegates at the event confirmed, the same stress test scenarios should not be repeated year on year, but continually developed in-line with company and market conditions to ensure the most valid and useful results and insight – as well as alignment with the spirit of the regulation (in the USA, the Fed is insisting that banks start afresh with their stress testing scenarios each year, and roll them up and down an organisation).
Beyond insight, on a practical level, realism of your stress tests – true-to-life applications – is required to gain executive buy-in. Being able to articulate both what you are doing in relation to stress tests and why, will avoid you falling into a “too model-based” approach.
The fact that stress testing takes a lot of time away from day-to-day activities means that banks should seek to create value from the exercise. Ultimately, stress tests should be a powerful tool for manifesting investor and management confidence – but, even with the exponential growth of banks’ stress testing departments, earmarking sufficient time and manpower to fully roll out stress testing across an organisation is still proving difficult to many.
Getting to grips with new regulations and their implications
As such, by way of a conclusion, it is clear that institutions across the board are yet to fully get to grips with regulatory stress testing requirements.
Certain larger banks are blazing a trail, building robust, repeatable and automated stress testing architectures, but many in the field are still carrying out task on an ad-hoc, somewhat tactical basis.
Consensus was reached amongst attendees that as regulators start to develop interoperability and standardise their stress testing requirements, the industry will follow suit. The institutions that face the greatest challenges are those which have activities spanning across jurisdictions.
Leading banks see centralised, data-based solutions, whether internally built or vendor-maintained, as market best practice, and disparate tactical solutions, like spreadsheets, are a hindrance and should start to be replaced if the industry is to progress.
Whatever the implications, and however institutions choose to deal with the inherent challenges, as Leif Boegelein addressed in his opening remarks – stress testing is here to stay.