How to Cope in a Regulatory and Market Environment Where You Rely on Stress Testing

6 March 2019

The 11th edition of the Global Risk Management Survey [1] from Deloitte Insights provides invaluable information related to how banks utilize stress testing in the current market and regulatory environment. The survey results are based on the responses from 94 financial institutions across the globe and the report is focused on the current trend of adopting stronger risk management practices in the industry.

One part of the report that jumped out at me is the increasing reliance on stress testing. The primary use of stress tests as reported by the respondents is to meet regulatory requirements, such as assessing the adequacy of capital and liquidity. 78% of respondents said they use the stress testing to assess concentrations and set limits internally. What I infer from this statistic is that the stress tests are fundamental in making risk, position, capital and liquidity decisions for the banks.

This brings me to RiskVal’s risk management system, RVPortfolio. If banks are relying more and more on stress testing, the stress test should be reliable, efficient and flexible. The stress test within the RVPortfolio system, allows for reports based on the largest market loss events over the past few decades such as 9/11 and the Lehman collapse. Custom scenarios can be created with detailed granularity to simulate potential shocks. Dozens of market factors are available on either absolute or relative value terms. RiskVal’s ease of use allows for manipulation of these factors in combination by implementing a historical correlation matrix among factors with configurable time horizons.


Numerous market and risk factors are included in the stress test such as:

• Yield Curves
• Swap Spreads
• Volatility
• Vol Skew

The results of each scenario are easily compared to the current mark-to-market of the portfolio to immediately understand the impact of market movements on value.

"Over the last decade, regulators' stress tests have been increasingly used by bank executives to evaluate the impact of big decisions on the business," Edward Hida, a partner with Deloitte's risk advisory unit and author of the firm's global risk management survey, said in an interview. "Banks may need to run these stress tests even more frequently — and especially when the market has such violent and volatile market swings as we're facing now." [2] The increasing need to run more stress tests in ever more volatile markets while making decisions about portfolio allocations should make the executives nervous about the underlying analytics and data. The analytics that drive RVPortfolio have been vetted by both buy-side and sell-side institutions throughout the fixed income markets, to the point that RiskVal’s derived analytical values have been used as a benchmark in the case of discrepancies between trading parties. RiskVal’s high quality market data has been vetted by front office traders for over 18+ years in the cash, futures and derivatives markets. Simply calculating accurate information is no longer enough; Risk Managers and Portfolio Managers require a system that helps them evaluate the impact of everyday trading decisions on a specific portfolio or the entire business.



Citations:

[1] Hida, E. Global Risk Management Survey. [online] Www2.deloitte.com. Available at: https://www2.deloitte.com/content/dam/insights/us/articles/4222_Global-risk-management-survey/DI_global-risk-management-survey.pdf [Accessed 4 Mar. 2019].

[2] Onaran, Y. (2019). Big U.S. Banks Are Letting Stress Tests Make Decisions for Them. [online] Bloomberg.com. Available at: https://www.bloomberg.com/news/articles/2019-01-23/big-u-s-banks-are-letting-stress-tests-make-decisions-for-them [Accessed 4 Mar. 2019].




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