Integrated Balance Sheet Modelling Key to an Effective Risk Management Strategy for EU-wide Stress Test Requirements
Experts at Wolters Kluwer Financial Services have outlined key steps when developing an effective risk management framework and strategy to the EU stress testing exercises, which began in 2014. Through applying an integrated balance sheet modelling approach and aligning the planning and stress testing framework with regulatory requirements, ICAAP/ILAA processes, financial and budgeting processes, financial institutions can not only develop an effective program to meet the ECB and EU regulators’ stress test requirements, but also embed a risk management culture which supports a sustainable business model.
Speaking at CFP Risk EMEA 2014 in London on 9 April, Nancy Masschelein, vice president, Market Management, Finance & Financial Risk Management at Wolters Kluwer Financial Services, emphasized to financial institutions the key tactical and strategic processes of implementing risk management framework to address the ECB and EBA requirements. In a speech titled ‘Effectively implementing a value adding enterprise-wide stress testing framework’, Masschelein advised on the following steps to effective implementation:
- Integrated balance sheet modelling as a key building block supported by a contract centric strategy;
- Adequately modelling market risk factors, expected behaviour of counterparties, credit risk factors and business strategy;
- Effectively integrating stress testing in banks’ risk framework and governance;
- Aligning the planning and stress testing framework with regulatory requirements, ICAAP/ILAA processes, finance and budgeting process.
Masschelein commented: “The implementation of an integrated risk framework across a business can develop a stronger and more robust model for stress testing capital, liquidity and funding across an entire enterprise. Implementing these necessary steps and processes not only helps firms meet the regulatory stress test requirements outlined by the ECB, it also helps to enhance business planning and strategy.”
The EBA announced the key components and draft methodology of the 2014 EU-wide stress tests on 31 January 2014 and 3 March 2014 respectively. The stress tests cover a three-year time horizon, until the end of 2016 with a main scenario and an adverse scenario, which are currently being defined. Financial institutions are required to stress risks such as credit risk, market risk, sovereign risks, securitization and the cost of funding. Both trading and banking book assets will be tested. For euro area firms, the stress tests are part of the ECB’s comprehensive assessment of their balance sheets and follow the asset quality review.
Wolters Kluwer Financial Services’ Risk Management solution addresses multiple risk calculations, including credit risk, liquidity risk, market risk, ALM, leverage, VaR, expected loss and RWA.