Tuesday, 5 May 2015

Reverse Stress Testing (RST): The Return of ‘Adequacy’



RST is one of the additional challenges that financial regulators have added following the financial crisis.  I spoke today on the subject at an event organised by the Institute of Risk Management. 

The effective implementation of RST builds on the articulation of the underlying business model.  This is something that UK supervisors have put on the agenda recently to signal a more holistic approach to supervision.  I have written a number of posts on the subject which you can access here.   

There are a number of challenges to deliver a RST.  The return of ‘adequacy’ might seem an odd title for my presentation.  It seeks to convey a simple message about the main challenge of RST: the assessment and judgement about the resilience of the business model.  It’s a ‘return’ because the term ‘adequacy’ used to be more prominent.  You may remember the Capital Adequacy Directive before it became the Capital Requirement Directive.  Anyway, the graph below seeks to illustrate the challenge of adequacy, which also serves to bring on a page the various stress and scenario tests that banks and insurers are considering on a regular basis. 



The key message from the graph is that if business failure scenarios are ‘close’ to the 1-in-200 scenarios, the adequacy of the business model and the strategy could be challenged.  Management may need to consider how to mitigate the risks to the business model. 

The full set of slides is available here.


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