Banks told to adopt new stress testing standards

The Bangko Sentral ng Pilipinas (BSP) has approved a new stress testing procedures on the bigger banks which have a large hold on financial stability due to potential systemic risk.

In a statement yesterday, the BSP said the “Guidelines on the Conduct of Stress Testing Exercises” defines the industry’s “overarching governance standards” and risk management expectations on stress testing practices. Banks have two years or until early 2020 to meet the requirements of the new circular.

Based on the Monetary Board approval, banks are instructed to use the stress testing exercises in considering its capital and liquidity planning as well as in setting risk appetite. They are also told to review results in planning for business continuity management, and in the case of domestic systemically important banks, in developing recovery plans.

“Banks are expected to employ a combination of different approaches for stress testing,” according to the BSP. Methodologies used could range from simple sensitivity analysis to the more complex tools, such as scenario analysis and reverse stress testing, said the BSP. The standards for the big banks will be different to that of standalone thrift banks, rural and cooperative banks which will have simplified requirements.

The guidelines are covered by BSP Circular No. 971 and are applicable to all types of banks on solo and consolidated bases. For banks that are part of a conglomerate or a group structure, stress testing exercises should be on consolidated basis or at the parent bank’s level.

Since stress testing is “a tool to evaluate the potential effects of specified changes in risk factors on a bank’s financial position under a severe but plausible scenario,” banks must develop “sound as-

sumptions generally depicting events or scenarios that may result in significant losses and to assess the impact of these scenarios on the bank’s performance or capital and liquidity positions,” said the BSP.

“For instance, banks may assume 50 percent default in the loan portfolio and assess its impact on capital adequacy ratio and level of available funds.”

The BSP added that stress testing will not only strengthen risk governance and help banks keep to the “safety and soundness” rule, it will also prepare banks for events with “severe financial impact.”

As such, in assessing results, banks could be proactive and build up capital to improve “resilience in times of actual crisis,” said the BSP.

The central bank has been conducting stress testing since 2011 on the bigger banks and the top thrift banks, and later issued a different scale for the smaller rural banks.

The big banks’ program took the BSP more than 12 months to set up after various consultations with the banking sector. The program has provided guidance on how banks will perform under such stress scenarios.

The stress testing program has helped the BSP determine how far local banks can absorb certain levels of stress, to assess the system’s weaknesses and capability to deal with shocks such as interest rates risk, foreign exchange risk and liquidity risk.

The BSP’s stress test program is similar to the US Supervisory Capital Assessment Program which is used to scrutinize banks’ capital, revenue and losses.