Regulation > Policy statement 09/20 Stress testing and scenario testing December 2009

Published: 18th December 2009

What's stress testing about?

The regulator is imposing a stress testing regime on firms because the risk management techniques employed before the crisis did not accurately reflect what could happen. In particular risk models allowed firms (and regulators) to ignore tail-risks. As a result many firms have found themselves badly exposed in the crisis. In order to mitigate against this happening again the FSA is making stress testing and reverse stress testing mandatory. Let's answer a few questions.

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This CP sets out the FSA's plans to reform the liquidity regime. It requires firms to undertake a much more rigorous analysis of their liquidity position. This includes the effect of stressed conditions on their business. The firm will submit what it considers to be an appropriate liquidity buffer to the regulator. The FSA will then decide whether it is sufficient. In determining the buffer the FSA will also assess the firm's systems and management. If these are considered weak the buffer will be increased accordingly. The liquidity buffer can only be held in liquid assets. The FSA's view is that this primarily means Gilts, sovereign debt or central bank deposits. The FSA makes it clear, "The responsibility of adopting a sound approach to liquidity risk management is on firms and their senior management".

What's your risk appetite?

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The regulator is asking boards to define their risk appetite and risk tolerance. Whilst this insistence may be reasonable it certainly doesn't make it any easier to do. Just how do you measure the level of risk you have and then how do you relate that to your firm?