The prominence of bank Stress Testing (ST) rose significantly following the financial crisis of 2008, although several shortcomings had been identified. ST is an important tool which should form part of the bank’s risk management framework. One of the main objectives of banks’ stress tests is to measure the bank’s resilience given forward-looking macroeconomic as well as hypothetical but plausible range of scenarios.
Although banks need to ensure that they have in place a ST framework, they need to ensure that it is in line with the relevant regulatory requirements, inter alia, CRDV, EBA Guidelines on institutions’ stress testing, (EBA/GL/2018/04), Banking Rule BR/12, etc.
Apart from having in place a ST programme, banks need to ensure that its governance structure is adequate such as that the Board approves, oversees the implementation and performance and challenges the ST framework. Moreover, adequate data infrastructure should be in place. Also, the bank’s ST programme should cover at least, all the material risks that the bank is or might be exposed to. Banks should ensure that severe enough scenarios are included in their ST and which must be relevant to its business model.
Moreover, banks must make use of ST in their ICAAP/ILAAP. Banks should use ST to evaluate the reliability of their capital and liquidity plans (also under stressed conditions) to ensure that they meet the applicable capital requirements and that they are able to meet their liabilities when they fall due. In addition, the ICAAP/ILAAP ST should be in line with the risk appetite and overall strategy of the bank.