The Assignment
A mid-level investing bank needed to implement a stress testing framework in accordance with guidelines issued by the central bank.
Our mandate was to develop a collaborative, auditable, repeatable, and transparent stress testing program to meet regulatory expectations, inform on the bank’s risk appetite framework, and improve strategic business decisions.
Our Solution
The solution included the following key features:
1. Stress testing
Our stress testing framework comprised of regular stress tests and scenario analysis with severe macroeconomic global downturn scenarios. We included all material risk types into our stress testing exercises which included portfolio- and country-specific stress tests.
2. ICAAP
Capital plan stress testing was performed to assess the viability of the capital plan in adverse circumstances and to demonstrate a clear link between risk appetite, business strategy, capital plan and stress testing.
3. Scenario Analysis
The stress test framework also consisted of defined macroeconomic downturn scenarios which were based on quantitative models and expert judgments, economic parameters such as foreign exchange rates, interest rates, GDP growth or unemployment rates.
4. Reverse Stress Testing
Reverse stress test were to be performed annually in order to determine the severity of scenarios that would cause the bank to become unviable.
5. Risk Reporting and Measurement
The stress testing framework supported regulatory reporting and external disclosures, as well as internal management reporting, to be presented to senior management as well as to the risk committees, who are responsible for risk and capital management.
Key Takeaways for the Client
A robust stress testing framework that integrated governance, documentation, data quality management, economic scenario development, loss modeling, forecasting, and reporting and incorporated participation of all stakeholders across business units.
The framework was integrated across asset classes and lines of business and enhanced risk management and was customized to the unique strategies and risks of the bank’s portfolio
INTERNATIONAL PARTNERS
NEW YORK & INDIA
Our work on Model Validation
The Assignment
The client, an investment bank, had to migrate to the Internal Model approach for the measurement of market risk. In accordance with SAMA and Basel guidelines, the bank needed to have their external models validated by a competent agency before applying for migration.
Our mandate was to find the gaps in the bank’s risk management framework to assess compliance with Basel norms.
Our Solution
The project involved the study of various FX, Interest rate, Commodities and equity products (including derivatives) which were being traded by the bank. Once the list of products was identified, our team then categorized at each product level to compute the risk at the market factor level and at the portfolio level.
The Model Validation Process involved building stand-alone models for each traded product for the calculation of factor sensitivities and Value at Risk (VaR) separately. In addition, the bank’s market risk management was validated on the following criteria:
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General criteria
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Qualitative Standards
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Market Risk Factors
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Quantitative Standards
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Stress Testing
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External Validation
This project also involved the validation and implementation of the Market risk model which needed to be compliant with the internal models approach of the bank. The results obtained from the exercise were then presented to the Bank’s Risk Management team and discussed. Subsequently, the application to SAMA to grant permission to move to IMA was developed.
Key Takeaways for the Client
Based on the validation tests, it was concluded that the models implemented by the bank were making relevant and appropriate calculation of VaR numbers. The models were determined to be conceptually accurate and adequately capturing all material risks. The formulae used in the internal models were determined to be conceptually correct and implemented with integrity. It was confirmed that the bank was in compliance with the quantitative and qualitative requirements for the adoption of internal Model approach for the measurement of market risk.