OSFI - Stress Testing

Question 1

What is the purpose of stress-testing? (4)

Answer 1

Risk: risk identifications & control (stress testing helps identify and control risk)
Complement: stress testing complements other risk management tools such as Best’s Capital Adequacy Ratio + simulate shocks
Cap: stress testing supports capital management
Liquidity: stress testing improves liquidity management

Question 2

Definition of stress testing.

Answer 2

A risk management technique TO EVALUATE the effects on financial condition of specified changes CORRESPONDING TO exceptional but plausible events.

Question 3

Describe - risk ID, control (regarding purpose of stress testing)

Answer 3

Risk ID: identify concentrations & interactions of risk

CONTROL: adjust individual portfolios, overall business strategy

Question 4

Describe - complement other tools (regarding purpose of stress testing)

Answer 4

• test statistical models USED to determine VaR

- simulate SHOCKS to test models robustness to economic changes

Question 5

Describe - supporting Capital Management (regarding purpose of stress testing)

Answer 5

Identify SEVERE events and/or COMPOUNDING events that impact capital requirements.

Question 6

Describe - improving Liquidity Management (regarding purpose of stress testing)

Answer 6

ASSESS liquidity profile & adequacy of buffers FOR institutional & market-wide stresses.

Question 7

Describe board versus management responsibilities regarding a stress testing program. (3 each)

Answer 7

BoD:
- Ultimate responsibility for program
- ensures management implementation of program
- should be aware of key findings
Management:
- implementation of program
- management of program
- planning for PAS (Plausible Adverse Scenario)

Question 8

List the 4 Rudimentary stress-testing considerations.

Answer 8

• Range of perspectives and techniques
• Update stress testing framework regularly
• Documentation
• Infrastructure

Question 9

Describe the rudimentary stress-testing consideration: Range of perspectives and techniques. (2)

Answer 9

Range of perspectives and techniques:

• perspectives: consult economists, actuaries, others
• techniques: qualitative, quantitative

Question 10

Describe the rudimentary stress-testing consideration: Update stress testing framework regularly. (2)

Answer 10

Update stress testing framework regularly:

• monitor EFFECTIVENESS of framework with qualitative and quantitative measures & UPDATE accordingly
• elements of a framework includes: documents, data quality, assumptions, …

Question 11

Describe the rudimentary stress-testing consideration: Documentation.

Answer 11

Documentation:

- provide written docs of assumptions, methods & fundamental elements of scenarios

Question 12

Describe the rudimentary stress-testing consideration: Infrastructure. (3)

Answer 12

Infrastructure:

• the framework should be flexible
• should allow increase in SENSITIVITY TESTING in times of rapid change
• should accommodate TIME HORIZONS for management action

Question 13

How to improve stress testing.

Answer 13

Rudimentary considerations, including making risks dynamic and reviewing assumptions more than once a year
- focus on PROGRAM, not just scenarios

Question 14

Considerations in scenario selection. (3)

Answer 14

• scenarios should cover all important BUSINESS & PRODUCT lines
• create NON-HISTORICAL scenarios (events that haven’t happened by COULD happen)
• severe & sustained DOWNTURNS (includes large losses, loss of reputation, legal problems, etc.)

Question 15

Focus areas in response to financial market turmoil. (5)

Answer 15

• Risk Mitigation
• S&W (Securitization & Warehousing)
• Reputational Risk
• Credit Risk & Counterparty Risk
• Concentration Risk

Question 16

OSFI’s consideration in assessing stress-testing program. (4)

Answer 16

• APPROPRIATENESS: are scenarios appropriate for institution’s risk profile?
• VIABILITY: are scenarios included that compromise viability?
• FREQUENCY: is stress testing frequent enough for timely management action?
• SEVERE SHOCKS: do scenarios include severe shocks, sustained downturns?

Question 17

Describe and contrast scenario with sensitivity testing. (3 each)

Answer 17

SCENARIO testing:
- significant changes to risk factors
- observe future state including ripple effect & management actions over a long time horizon
- more complex & comprehensive
SENSITIVITY testing:
- incremental changes to risk factors
- shock is more immediate & time horizon shorter
- simpler, fewer resources required