By Ilias Georgakopoulos, Analyst - Banking Supervision, MFSA
Stress testing involves examining how an object or system copes under a significant amount of pressure. The aim is to test how resilient it is under extreme conditions. It is a tool used in a number of industries, from construction to cardiac health care. For example, engineers stress test construction materials to assess how they behave when subjected to strain.
When applied to banks, stress testing involves testing the resilience of banks to severe but plausible shocks. In practical terms, this typically involves modelling the impact of adverse forward-looking macroeconomic and financial scenarios on bank profitability and balance sheet. As a result, stress testing is an important tool that should be an integral part of the risk management framework of a bank.
Last month, the MFSA held an industry webinar on the regulatory expectations of a stress-testing framework for banks. The webinar provided insights on what an appropriate stress framework should look like and how stress test outputs should interact with the risk management framework and recovery plan. The webinar, which was attended by over 100 industry delegates was targeted towards bank officials who work in the area of risk and finance, as well as managers of consulting firms providing technical support to credit institutions.
In his opening address, David Eacott, Head within the Banking Supervision function at the MFSA, noted the importance of stress testing in capturing the risk profile of a bank accurately. He also highlighted the role of stress testing in providing meaningful insights to management. Ilias Georgakopoulos, Analyst within Banking Supervision at the MFSA, outlined in detail the expectations of the MFSA. In particular, he emphasised that credit institutions should demonstrate that they have in place an appropriate stress testing framework. This should be in line with their business model, size and complexity, supported by good governance arrangements and data infrastructure and should form part of the bank’s risk management framework and strategic planning.