By Sophie Bottazzi, Senior Research Executive, CeFPro
The EU-wide stress test draft methodology, templates and guidance were recently been published, while Stress Testing experts across Europe continue to grapple with keeping up with emerging trends and using these tools in practice to produce informed business decisions. As the industry matures and global regulatory expectations are better understood, the focus shifts towards BAU and managing Stress Testing on a continual basis. CeFPro’s 7th Annual Stress Testing Summit addresses the critical challenges and approaches, regulatory change, technological advances, to allow like-minded professionals to better understand and manage the risks. Join us on 12-13 November in London to network and interact with peers across two days of interactive case studies, presentations, panel discussions, networking breaks and more – for full information visit: www.cefpro.com/ste
Having undertaken up to 50 one-on-one interviews across 40 different banks and 15 countries, CeFPro found a number of overlapping concerns and challenges ahead of the 2020 stress test. One of the core challenges centered around the regulatory requirements, including jurisdictional variations. For example, managing the non-alignment, which creates inefficiencies for banks and supervisors, is a major concern, with a clear need to go beyond regulatory requirements. The ability to use technological and data advances to overcome these challenges is one possible solution though the practicalities of implementing these are a challenge in themselves.
Submitting within predefined timescales set by the regulators, along with internal banking requirements – departmental reporting lines, gathering data, written reports and so on – create enormous challenges in getting internal approval before submission to regulatory authorities. Creating effective reporting structures, with a coherent bottom-up approach across different business lines, is a key challenge for many financial institutions. Getting senior management buy-in, as well as understanding, prior to submission deadline is also a key challenge. With continuing pressure on banks’ resources and time, submitting in a timely manner according to regulatory requirements, is an ever-present challenge and one that needs to be addressed by senior management.
Another interesting development, according to CeFPro’s research, centred around the modelling techniques for non-financial risks. Two key challenges highlighter were on the increasingly important topic of climate change and around the uncertainty of Brexit. With regards to climate change, increasing regulatory (and political) pressures bring a new dimension to banks stress test. The need to align financial risk polices centred around environmental impact business lines, with increasing scrutiny and environmentally aware investors and Boards, requires new and innovative approaches to modelling non-financial risks that have a direct impact on business units. In doing so and addressing a top down and bottom up approaches to identify key risks. All combined, stress testing climate change, incorporating environmental, social and governance risk to stress testing requires multi-departmental interaction, aligning risk policies, effective communication to investors and with the Board and also effective assessment of credit risk of carbon transition companies.
A further challenge for modelling techniques for non-financial risks centred around the uncertainty of Brexit. How can financial institutions use stress testing as a tool to prepare for Brexit, and how can they review the potential economic impacts across markets? Many unanswered questions on the impact within the UK marketing, which sectors will have the greatest impact and what the access will be various markets, should a ‘hard Brexit’ occur. Moreover, there are questions around investor and liquidity movements, political uncertainty (two UK Prime Ministers since 2016, possible UK general election on the horizon…) and geopolitical scenarios all raise questions on non-financial risks, and how financial risk professionals can effectively incorporate these unquantifiable elements within stress testing.
The finally point and another hot topic throughout our research was leveraging the outcome of alignment of IFRS 9 and Stress Testing. The key focus highlighted by professionals was to have a better understanding of the impact on provisioning and capital allocation. How can financial risk professionals effective review and adapt IFRS 9 capabilities into stress testing process? Aligning stress testing and IFRS 9, limiting duplication of efforts with forward projections, re-using modelling approaches across institutions are, for many, an efficient use of resources and time for the 2020 stress testing process, allowing better informed business decisions. Questions are raised as to the viability and effectiveness, though many financial risk professionals that CeFPro spoke to believe this could be an effective work-around.
Overall, the 2020 stress tests have come a long way over the last ten years, with a high focus on emerging treads, the challenges on time and resources, using existing tools and techniques, to effectively complete the 2020 stress tests. The findings of CeFPro’s research will be demonstrated on November 12-13 2019 at the 7th Annual European Stress Testing Summit in London. We invite you to join your peers for two days to discuss upcoming Stress Testing trends, technologies and regulatory requirements. The agenda can be viewed at www.cefpro.com/ste. For further information, please get in touch with a member of the team on +44 (0) 207 164 6582