CREDIT STRESS TESTING FRAMEWORK USES & CHALLENGES TO BANK - PowerPoint PPT Presentation

CREDIT STRESS TESTING – FRAMEWORK USES & CHALLENGES TO BANK MANAGEMENT USES & CHALLENGES TO BANK MANAGEMENT Jürgen Wienes Richard Vasicek Group Risk Management Enterprise Risk Solutions UniCredit Group UniCredit Group Moody's Analytics Moody s Analytics Chicago, 16 th October 2012

Maintainance Of Sustainability & Licence For An Institution: Multiple Factors Demand Sophistacted Usage Of Stress Testing Regulatory Compliance? g y p Systemic Contagion? Systemic Contagion? Solvency Source and Victim Consistent Stress Test Analytics Analytics Resilience To Downturn? Investor Confidence? L Loss Absorption Capacity Ab ti C it Cost of Capital and Funding 2

Variety and Pace of New Regulations for Banking System Many are directed at bank capitalization with need to stress test. 3 Source: McKinsey, BCBS; Dodd-Frank Act; CRD2/3/4; EMIR

Key Challenges for Stress Testing To Maximize Its Utilization 1. Managing complexity at Senior Management level deriving from different frameworks, purposes and methodologies. Therefore design, interpretation of results and managerial actions need to reflect such choices. 2. Firm-Wide Stress Testing : As “Silo”-approach may lead to substantial under-estimation of stress impacts, Enterprise Risk Management captures Risk Types, Balance Sheet and Liquidity together. 3. Support the Bank’s planning process , Stress Testing is considered an important tools to assess the robustness. 4. Applicability of Platform: To become useful, key drivers and model parameters have to be understood and pp y y p incorporated. Allow Reverse Stress Testing to capture systemic and idiosyncratic vulnerabilities undermining the Business model viability 5. Contingency Plans : correctly identifying triggers and relevant actions for facing the potential consequences T STRESS TEST K IS A MUST RAMEWORK TEGRATED S INT F 4

1. Managing Complexity Regulatory Requests For Stress Testing Has Been Growing In Importance and Numbers Over The Few Years p A third of the top 1000 banks now have The regulatory pressure has increased to comply with three or more stress y substantially since 2009 with the emergence y g testing requirements per year* of global and local regulations Global and local stress testing specific regulations Regulatory requirements have increased, both in 2 nd EBA o 2 EBA rk Key To number and complexity stress test CEBS Guidelines More requests: EBA, IMF, Basel, Local » lexIty - 14 First EBA More stringent: Bank-wide and bank-specific, » stress test Reverse ve" Comp Framewo 12 11 requirements + BIS More frequent: quarterly to annually » Principles More transparent: market confidence » 10 14 Basel II objective/disclosure Pillar 2 i.e. "Surviv 8 8 8 8 Germany Germany CEBS CEBS ntegrated Complexity of Guidelines 5 EBA is a major annual exercise in Europe i.e. UK, Australia, 6 3 Top 91 banks, covering 65% of the European » Sweden banking assets and at least 50% of all banking Stress testing & 1 Liquidity Risk 4 assets in each EU country assets in each EU country - In Expanded to additional banks by local » 2 regulators 2005 2006 2007 2008 2009 2010 2011 2012 Source: Market research and own analysis using a sample of 50 countries including G20, EU Comprehensive and complex exercise » and BCBS members Number of country-specific regulations or guidelines issued for the given year 5 * 3+ Stress testing requirements include: IMF, EBA, local regulation, CEBS guidelines and Basel 3 guidelines Source: Moody's Analytics own estimate based on EBA data, regulatory websites and market research.

1. Managing Complexity Different types and usages of stress testing require a clear strategy for communicating results to Senior Management g g Major Types of Usage of Output Recipients of Stress Testing condition Stress Testing Stress Testing and actions deployment for successfully successfully integrating  Sensitivity Analysis  Regulatory:  Capital Supervisory Stress Test  ICAAP Authority Adequacy in Bank’s  European Stress Test  Scenario Analysis management Assessment  SIFI (Systemically  Reverse Stress  Robustness of Important Financial Top Need to Testing Institutions) Business  Other national integrate Management Other national Strategies Strategies different regulators’ results to form  Contingency requests a unique view  Managerial: on a Bank’s Plans  Managerial capital and  Risk Appetite  Risk Appetite business Actions  On-going Stress Test strategy  Contingency soundness Focus on specific Plans sub-portfolios’ Deployment Deployment vulnerabilities  Stress Testing is performed according to different design along intended usages (Regulatory and Managerial). All results need to be successfully and clearly communicated to a Senior Management.  To improve the communication, all the relevant stakeholder (Top Management and Business) need to be involved in the process, starting from the definition of the scenarios down to the sharing of the 6 output and final decision process.

2. Firm-Wide Stress Testing: From Risk-wide Stress Test to Enterprise Risk Management Understanding and Capturing the Linkages g p g g ASSETS LIABILITIES Risk Map   Loans and Receivables with Deposit From Banks  Credit Risk  Deposits From Banks Customers And Debt  Market Risk   Securities In Issue Securities In Issue Market Risk Loans and Receivables with Loans and Receivables with Ri k Wid Risk-Wide  Financial Liabilities  Operational Risk Customers Held For Trading Integrated   Financial Investment Risk Financial Assets held for  Financial Liabilities Designated At Fair trading Stress Test  Real Estate Risk Value Cash and Cash Balances  Hedging Instruments  Business Risk  Business Risk   Financial Investments Financial Investments  Provisions For Risk P i i F Ri k  And Charges Hedging Instruments  Tax Liabilities  Property, Plant and  Liabilities Included In Equipment Disposal Group  Many banks performed risk wide S.T. including credit  Classified As Held For Goodwill Sale Sale  Other Intangible Assets Oth I t ibl A t risk, market risk, operational risk, but ...  Other Liabilities  Tax Assets  …. risk wide S.T. underestimates the true risk because  Shareholders’ Equity:  Non-Current Assets and  Capital and Reserves it does not take into consideration other elements of  Available-For-Sale Disposal Groups Classified Assets Fair Value balance sheet coming from liabilities (e.g. deposits, as Held For Sale Reserve and Cash-Flow  O h Other Assets A own bonds,…) and more in general all the liquidity risk Hedging Reserve  Net Profit (Loss) elements. (Firm wide S.T.)  Banks have to improve S.T. methodology in order to really capture and manage all kind of risk. Vice versa a Enterprise Risk Management Enterprise Risk Management stress scenario coming from an increase of reputational risk instead of a sovereign default or  Bank Balance Sheet Structure recessive outlook could affect more on the liquidity  Business Strategies vs. change of market trends side. (The 2009 crisis provides impact both from credit and liquidity side) and liquidity side). Firm-Wide Stress Test 7

3. Planning Process: Stress Testing integral part the Bank’s planning process to show robustness of Strategy and Budget-Assumptions gy g p Key performance indicators Business P&L “Book Capital” Strategy Forecasting Model common equity q y (Target volumes (Target volumes, (raises/buybacks) growth, risk appetite, target rating, Dividends/Retained dividend, policy, cost earnings Balance Sheet strategy, M&A,…) Minority interests Minority interests Forecasting Forecasting Sub debt maturing/issuance Inputs to stress (risk Provisions/EL/Deductions factors) factors) • Credit drivers (PD, LGD, Systemic risk EAD) RegCap Macroeconomic • Losses (€) Losses (€) RWA = f (EAD PD LGD) RWA = f (EAD, PD, LGD) Scenarios • Liquidity drivers (funding (Regulatory/ risk, concentration risk…) Business) • Market Drivers (Interest ( ECap ECap rates, FX, housing EC = f (EAD, PD, LGD, prices…) correlations) Source: Moody's Analytics With all that properly defined as objective, where is an institution in its capabilities and what does 8 the technical platform need to provide differently to the past?