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CEBS Outputs Another CP, This Time on Risk Stress Testing Best Practices

The Committee of European Banking Supervisors (CEBS) has added another document to the industry’s Christmas reading list with the publication of its revised guidelines on stress testing, otherwise known as CP32. The new guidelines, on which the industry has until 31 March to comment, include details of the scale of the data management challenge posed by these on demand stress testing requirements.

The UK Financial Services Authority (FSA) has already been very prescriptive about its own approach to stress testing requirements, whereas CEBS has tended to adopt a softer approach to its industry guidelines over the course of the year. Regulators (other than the FSA of course) have been waiting with baited breath for these consultation papers and those from the Basel Committee of Banking Supervision (BCBS) in order to base their own regulatory approach on the recommendations contained within.

These revised guidelines in particular draw on the experience that supervisors have obtained by reviewing institutions’ stress tests in recent years, says CEBS. They also take account of the revised principles for sound stress testing practices and supervision published by the BCBS earlier this year. Accordingly, they are designed to assist institutions and supervisors in achieving robust, methodologically sound outputs that are effective in identifying risks and their potential mitigants during stressed conditions and their overall impact on an institution.

The guidelines aim to assist institutions in designing and implementing stress testing programmes with a robust governance structure, meaningful senior management engagement and an effective infrastructure, including information technology, data handling and skilled human resources, says CEBS. The revised guidelines also provide assistance to supervisors in their assessments of institutions’ stress testing. It is intended that the guidelines should be implemented by institutions proportionately, having regard to the nature, scale, and complexity of the activities of the institution concerned, rather than adopting a one size fits all approach.

The revised guidelines are designed to be as practical as possible and aim to identify the relevant “building blocks” in an effective stress testing programme, says the regulatory body. To this end, CEBS explores recent developments in stress testing and how financial institutions in the post-crisis environment should adopt these, including the application of CEBS’s own “High level principles for risk management”.

CEBS recommends the use of simple sensitivity analyses and more complex scenario stress testing in order to achieve a more transparent insight into gaps and inefficiencies, as well as a multi-layered approach from portfolio level to firm-wide tests. It charges the senior management of a financial institution with the responsibility of ensuring these changes are implemented and recommends the appointment of a stress testing committee.

The two most challenging aspects of the recommendations (in line with what A-Team Group has identified in other similar regulatory publications of late) will be drawing together the risk data from across the firm and having in place a platform in place that is sufficiently flexible to enable “modelling of a wide variety of stress tests across business lines and risk types as and when the senior management require”.

The CP states: “Institutions must ensure that they devote sufficient resources to developing and maintaining such infrastructures including appropriate resources and IT systems that facilitate effective data delivery and processing in a quantitative and qualitative manner.”

CEBS also recommends that “data quality” should be considered directly when assessing the suitability of the stress testing platform. “CEBS will expect its members to apply the present guidelines, once finalised, by 30 June 2010. CEBS acknowledges that the implementation of some specific aspects of the guidelines may require modifications to institutions’ current procedures. Therefore, CEBS recommends that the implementation of the guidelines can be phased, and – whenever necessary – national supervisors provide their supervised institutions with sufficient flexibility regarding the implementation of specific aspects of the guidelines (for example, reverse stress testing). National supervisors will also monitor the implementation progress, as necessary,” the CP states. Effectively leaving it up to the national regulators to chase compliance in six months’ time.

Along with the CEBS CP on concentration risk published earlier this week, the guidelines will be discussed during a public hearing on 10 March 2010 at CEBS’s premises in London, from 10am to 1pm.

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