FSA introduces new stress testing requirements
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The Financial Services Authority is introducing new stress testing requirements for firms, including reverse stress testing.
The FSA says it expects firms to develop, implement and action a robust and effective stress testing programme which assesses their ability to meet capital and liquidity requirements in stressed conditions.
As part of its more intrusive supervisory approach the FSA runs its own stress tests on a periodic basis for number of firms. This is carried out regularly for specific high impact firms and for other firms as the need arises, to assess their ability to meet minimum specified capital levels throughout a stress period.
Reverse stress testing will sit alongside the current range of stress tests that firms are required to carry out to ensure that firms identify and assess scenarios most likely to cause their current business models to become unviable.
Firms subject to the new reverse stress testing requirement will have 12 months to incorporate reverse stress testing into their current suite of stress tests and risk management tools.
Alongside today’s policy statement, the FSA published a short consultation paper clarifying its approach to capital planning buffers. The CPB is the amount of capital that a firm should hold now so that it is available to absorb losses and meet higher capital requirements in adverse external circumstances such as an economic downturn.
The FSA is consulting on simplifying its approach and has provided further clarity about expectations on the use of the CPB and the mechanism by which firms can draw down the buffer. This is an initial step in improving firm’s capital ahead of international discussions which will take place in 2010.
Paul Sharma, director of prudential policy at the FSA, says: “Stress and scenario testing should be an important element in firms’ planning and risk management processes. These changes send a clear signal to firms’ senior management that they need to engage in building a robust stress testing infrastructure as an important part of effective risk management, and use that to assess capital needs in a stress.
“Reverse stress testing is a separate, but complementary exercise. It is essential that firms identify what could cause their business to fail and use this information to ensure that the relevant risks are sufficiently well-understood and appropriately managed to secure consumer protection and market confidence.”
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