PRA endorse EBA Guidelines on institutions’ stress testing

PRA Regulatory Round-up, January 2019:

 

“In December 2018 the EBA published its final report on the EBA Guidelines on institutions’ stress testing

The Guidelines will apply to all firms in 2019 and will assist firms to identify, assess, measure, and manage tail risks

The PRA will refer to the Guidelines when assessing the quality of firms’ stress-testing programmes

The PRA expect firms to reflect on how they will incorporate the new Guidelines into their stress testing practices…”

 

The Guidelines are extensive – 40 pages and 199 clauses

 

  • However, much of the material simply restates or embellishes standards already established for UK institutions by the PRA
  • These notes do not therefore seek to present a comprehensive exposition of the Guidelines, but emphasize the increasing regulatory pressure, on all institutions, irrespective of size and systemic importance, to allocate proper resources to stress-testing across liquidity, capital and recovery planning

 

EBA: “The management body of the institution should ensure that clear responsibilities and sufficient resources (e.g. skilled human resources and information technology systems) are assigned and allocated for the execution of the [stress-testing] programme”

 

To ensure:

 

  • that a proper data infrastructure has been put in place, institutions, including those that are not global systemically important institutions (G-SIIs), should endeavour to also refer, to the extent appropriate, to the principles for effective risk data aggregation and risk reporting of the Basel Committee on Banking Supervision [BCBS 239]
  • that the data infrastructure allows for both flexibility and appropriate levels of quality and control.

 

Institutions should:

 

  • devote sufficient human, financial and material resources to guarantee the effective development and maintenance of their data infrastructure, including information technology systems
  • ensure that data are aggregated on a largely automated basis so as to minimise the probability of error.
  • In particular, a thorough reconciliation and controls system should be in place”

 

Liquidity Stress -Testing

 

  • Liquidity stress test metrics should include, if appropriate and in particular for at least all material currencies, a granularity per currency to allow the analysis of currency-specific assumptions in scenarios (e.g. volatility in exchange rates or currency mismatches).
  • Institutions should, where appropriate, integrate liquidity stress test in their institution-wide stress tests, and take into account differences in the time periods covered in liquidity stress tests from those covered in institution-wide solvency stress tests.
    •  At a minimum, institutions should assess the impact of increasing funding costs on P&L

 

Concentration Risk

 

In assessing this risk in their stress testing programmes, institutions should take into account the credit risk of each exposure but also consider the additional sources of risks arising from the similar behaviour of certain exposures (i.e. higher correlation). These additional sources of risk under analysis should cover, but not be limited, to the following:

  • the single-name concentrations (i.e. client or group of connected clients as defined in Article 4(39) of Regulation (EU) No 575/2013);
  • the sectoral concentrations;
  • the geographical concentrations;
    • [All covered under the PRA’s HHI methodology, but not:]
  • the product concentrations; and
  • the collateral and guarantee concentrations

 

IRRBB

 

  • The interest rate scenarios used for stress testing purposes, including for the purposes of the application of Article 98(5) of Directive 2013/36/EU [200bps shock produces negative 20% impact on EVE] for the interest rate risk arising from the non-trading activities, should be adequate to identify all material interest rate risks, e.g. gap risk, basis risk and option risk [and repricing risk, as per the PRA]
  • Institutions should ensure that the tests referred to in the previous paragraph are not only based on a simple parallel shift but that they consider movements and changes in the shape of the yield curves in their scenario analyses
  • Where less complex financial instruments are employed, institutions should calculate the effect of a shock using sensitivity analysis (without the identification of the origin of the shock, and by means of the simple application of the shock to the portfolio

 

KnowCo is a long-term, dedicated GRC support partner for UK banks
Since our foundation in 2010 we have served more than 40 UK institutions in assignments including

ICAAP, ILAAP, RRP, Funds Transfer Pricing, Stress Testing (Liquidity and IRRBB), Credit Risk Capital (Pillars 1 and 2A)

And now, IFRS 9 administration, control and reporting via The IFRS 9 Manager system

 

 

 

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