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Majority of Risk Managers Have Yet to Put in Place Adequate Stress Testing Procedures, Says PRMIA

Despite the moves within the regulatory community towards mandating reverse stress testing procedures, the majority of firms have yet to take action and put in place new procedures and systems to cope with the changes, according to a recent survey conducted by the Professional Risk Managers’ International Association (PRMIA). Reverse stress testing is just one of the areas that risk managers have to tackle in the face of the deluge of new regulatory requirements and it is telling that 56.7% of the 360 respondents to the SunGard sponsored survey had not yet begun on the road to meeting these requirements.

Reverse stress testing best practices were first elaborated upon in detail back in December last year by the Committee of European Banking Supervisors (CEBS) in its consultation paper CP32 and firms have since been assessing their impact. However, it appears that only 8.2% of risk management respondents to the PRMIA survey have added reverse stress tests to their current risk management regime, with 35.1% performing reverse stress tests on a more ad hoc basis.

This is not reassuring news for those risk managers based in the UK given that the Financial Services Authority (FSA) has indicated that firms must submit their implementation plans for reverse stress testing by next month, and other regulators are set to follow in the near future. In the UK, firms must identify the state of their current stress testing frameworks and their planned changes to quantitative and qualitative systems, including set milestones to be achieved in the run up to the 14 December implementation deadline.

Counterparty stress testing is also an area that needs improvement, if the survey results are anything to go by, with only 13.2% of respondents running these tests on a monthly basis and regularly reviewing their scenarios. A worrying 35.1% still don’t have counterparty stress tests in place and 36.6% run the tests but only four times a year.

Moreover, the firms that do run counterparty risk stress tests are not doing so in a broad enough manner and the survey indicates it is “still an immature area of risk management with best practice yet to be achieved at many institutions”. This is reflected by the fact that 31% use individual market factors in these tests, 27.6% use multiple market factors in aggregate and only 18.1% stress both market factors and counterparty credit grades in a consistent manner.

Despite the sound and fury that has been going on within the industry about the development of measurements for credit valuation adjustment (CVA), it seems that the majority of firms have not yet invested in this functionality. The vendor community is certainly pushing the agenda and there have been a number of launches around CVA this year, but only 5.8% of respondents to the PRMIA survey indicated they have a CVA system already in place. A whopping 61.9% have nothing in place at the moment.

Credit back testing is another weak spot, according to PRMIA, with only 16.6% of respondents with a system in place to measure this metric. “This is another area that will require significant investment in data and systems going forward,” notes the PRMIA report.

The Basel Committee on Banking Supervision’s (BCBS) December papers on capital and liquidity risk identified poor operational effectiveness of banks’ collateral departments due to poor systems, data integrity and low staffing levels as a serious problem, and the PRMIA survey reflects this statement. Only 14.7% of respondents believe that they already have a collateral management department that performs well across the board. When asked whether deficiencies in current capabilities was due to systems or people the responses were 4 to 1 in favour of needing better systems (29% versus 8%).

However, the survey reflects that there has been some progress towards understanding these risk management challenges better since last year if you compare the results to a similar PRMIA and SunGard effort conducted in March 2009. The 2009 survey indicated many firms were unaware of underlying issues in risk management and had not yet invested in new systems.

Mat Newman, head of product management at SunGard’s Adaptiv business unit, reckons this year’s survey highlights the serious need for further investment in risk management going forward. “Systems that are effective in handling a range of stress testing, risk measurement and other collateral management aspects in an integrated fashion will help banks and the industry to gain strength and stability,” he contends. And this is exactly where SunGard is hoping to pitch its wares.

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