In view of the aftermath of 2008 global financial crisis that led many banks and supervisory authorities across the world to question whether the existing stress testing practices are sufficient and robust to cope with the rapidly changing circumstances, the Reserve Bank of India (RBI) has issued updated guidelines for stress-testing of banks which will be effective from April.
According to the guidelines, banks will have to stress-test themselves using shock scenarios involving credit risk, market risk, foreign exchange risk, interest rate risk and equity price risk. Among other things, the guidelines also cover on overall objectives, governance, design and implementation of stress testing programmes.
Further, RBI expects that the degree of sophistication adopted by banks in their stress-testing programmes to commensurate with the nature, scope, scale and the degree of complexity in the bank's business operations and the risks associated with those operations and accordingly has decided to classify banks into three categories. Under the classifications, the first group has risk-weighted assets (RWAs) of over Rs 2 lakh crore, the second RWAs between Rs 50,000 crore and Rs 2 lakh crore; and the third RWAs of under Rs 50,000 crore.
Additionally, the new guidelines underscored that stress tests should be conducted at least annually and the assumptions underlying the stress tests should be reviewed periodically. Such periodic reviews are necessary to ensure the integrity, accuracy and reasonableness of the stress testing framework. Also, it is required by the banks to communicate their risk profile to the respective boards and senior management for setting risk limits and allocating capital for various risks. Meanwhile, the guidelines mandate banks to preserve the document for stress tests undertaken by them, the underlying assumptions, the results of the tests, for a span of at-least five years.
According to the guidelines, banks will have to stress-test themselves using shock scenarios involving credit risk, market risk, foreign exchange risk, interest rate risk and equity price risk. Among other things, the guidelines also cover on overall objectives, governance, design and implementation of stress testing programmes.
Further, RBI expects that the degree of sophistication adopted by banks in their stress-testing programmes to commensurate with the nature, scope, scale and the degree of complexity in the bank's business operations and the risks associated with those operations and accordingly has decided to classify banks into three categories. Under the classifications, the first group has risk-weighted assets (RWAs) of over Rs 2 lakh crore, the second RWAs between Rs 50,000 crore and Rs 2 lakh crore; and the third RWAs of under Rs 50,000 crore.
Additionally, the new guidelines underscored that stress tests should be conducted at least annually and the assumptions underlying the stress tests should be reviewed periodically. Such periodic reviews are necessary to ensure the integrity, accuracy and reasonableness of the stress testing framework. Also, it is required by the banks to communicate their risk profile to the respective boards and senior management for setting risk limits and allocating capital for various risks. Meanwhile, the guidelines mandate banks to preserve the document for stress tests undertaken by them, the underlying assumptions, the results of the tests, for a span of at-least five years.
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