Dr Mario Onorato, Senior Director of Balance Sheet & Capital Management Solutions at Algorithmics and Honorary Senior Lecturer, Cass Business School in London, said: âIt is clear that banks need to move away from their, in the main, siloed approach to risk management. To achieve this, senior management and the board must actively participate in implementing an institutionâs enterprise-wide integrated stress testing framework, including scenario selection, and also ensuring that there is a robust stress testing infrastructure with appropriate IT systems and resources in place. In my opinion, the most important elements of the guidance are the requirement for banks to implement enterprise-wide and reverse stress testing frameworks, since both of these approaches will allow banks to rise above the silos to perform fully integrated stress testing.â
Algorithmicsâ response focused on:
â¢ Reverse Stress Testing
Few institutions have the technological ability to undertake reverse stress tests and will require significant effort to build and incorporate this into their overall stress testing framework. Banks will need additional clarity on how the Agencies intend to use the results, and the need for consistency with other international regulators.
â¢ Regulatory arbitrage will become a danger. To avoid it, Algorithmics recommends the Agencies should create minimum common scenarios which all organizations will need to incorporate on top of their current stress testing programs.
â¢ Need for stress testing benchmarks
Because stress testing frameworks differ widely between institutions with different activities and contexts, and because local credit conditions vary, Algorithmics recommends that some standard stress coefficients or models should be suggested by the Agencies as a benchmark.
Dr Onorato concluded: âBanking is an international business and it is essential that there is consistency in regulation worldwide if regulatory arbitrage is to be prevented. The Agenciesâ proposal differs from Basel and FAS by not acknowledging the need for common supervisory scenarios for banks to report under. It is important for banking organizations to realize that not all banking failures are driven by lack of capital. Operational risks or changes in the market perception of an institution can also cause institutional failure and these factors must also be included in the enterprise stress testing framework.â