The Financial Services Authority has published a feedback statement on stress testing in firms' risk-management frameworks, summarising the comments it received to its stress testing discussion paper and its responses to them.
The FSA published Discussion Paper 05/02: Stress Testing in May 2005, setting out the main findings of two surveys it carried out in 2002 and 2003 into the form and nature of stress testing undertaken by banks, securities and insurance firms, and establishing the extent to which firms were integrating stress testing into their risk-management frameworks.
The FSA says the feedback statement should be read by any firms which have been, or will be, affected by the Individual Capital Adequacy Standards (ICAS) and the implementation of the Capital Requirements Directive (CRD).
The feedback statement states the FSA is encouraged that respondents to the discussion paper and participants at its conference on stress testing in September generally agreed that:
- Stress testing should form an integral part of a firm’s risk-management framework;
- Senior management should be fully engaged in a firm’s stress testing processes; and
- Improved stress testing methodologies within firms, particularly within the larger and more complex institutions, would strengthen the overall stability of the financial system.
Most responses to the discussion paper emphasised there is no appetite for additional formal guidance or new rules to be issued on stress testing, claims the FSA, beyond those likely to be required by the implementation of the CRD or currently imposed by the ICAS. Respondents felt they were best placed to identify risks, given the particular risk profiles, markets and environmental factors they were subject to.
The FSA says it will therefore not set specific scenario analyses for firms and will not be prescriptive in its approach to setting stress testing requirements for firms. It adds that within the constraints imposed by the requirements of the CRD and ICAS, firms should determine their own strategies for designing and developing stress testing methods.
But, the FSA says it will continue to challenge the appropriateness of stress tests undertaken by firms and will incorporate reviews of these tests into its Arrow risk-assessment framework.
It adds that some extra guidance is necessary, particularly to identify and share good practices, and it therefore intends to:
- Issue a further Consultation Paper on implementing the CRD in February 2006 which will set out additional guidance;
- Undertake a series of thematic visits to a selection of firms starting near the end of the first quarter of 2006 to examine existing practice of their firm-wide stress testing;
- Issue a “Dear CEO” letter as a result of the thematic review, probably in the third quarter of 2006, setting out the findings of the reviews, its expectations of future developments in light of the CRD and the sharing of good practice; and
- Assess stress testing methods through its risk-assessment framework, Arrow.
The FSA uses the term “stress testing” to describe both stress testing and scenario analysis. It states that stress testing typically refers to shifting the values of individual parameters that affect the financial position of a firm and determining the effect on the firm’s business. Scenario analysis examines the impact of catastrophic events on a firm’s financial position.
If you have any comments you would like to add to this story or would like to speak to its author about a similar subject, telephone Emily Perryman on 020 7968 4554 or email [email protected].IFAonline
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