Benchmarking of Stress-testing Practices in relation to Treasury Activities

Circulars
23 Nov 2006
Benchmarking of Stress-testing Practices in relation to Treasury Activities Our Ref: B1/15C 23 November 2006 The Chief Executive All authorized institutions Dear Sir/Madam, Benchmarking of Stress-testing Practices in relation to Treasury Activities The Hong Kong Monetary Authority ("HKMA") has completed a benchmarking exercise on the stress-testing practices of selected authorized institutions ("AIs") in relation to market and interest rate risks associated with treasury activities. The objective of the exercise is to assess the effectiveness of selected AIs' stress-testing practices and to identify good practices for sharing with the industry. The majority of AIs tested have put in place satisfactory stress-testing practices. We have also identi￾ed certain de￾ciencies in some cases that will require improvements to bring them in line with the requirements set out in Module IC-5 "Stress-testing" of the Supervisory Policy Manual ("SPM"). To help facilitate the effectiveness of stress-testing, some observed good practices are set out in the Annex for your reference. In view of the important role stress-testing plays as an integral part of the risk management framework, management of AIs must regularly review their stress-testing practices and actively introduce enhancements whenever necessary. In particular, management should be vigilant, proactive, and involved in reviewing the scenarios used in stress-testing to ensure that they are relevant and su￾ciently vigorous, and de￾ning clearly their risk tolerance level for immediate escalation and remedial actions. Should you have any questions on the above, please feel free to approach your usual supervisory contact at the HKMA or Mr. Terry Sham on 2878 1443. Yours faithfully, Arthur Yuen Executive Director (Banking Supervision)

Encl. Annex - Good Practices for Stress Testing (Word ￾le, 40KB) Last revision date : 01 August 2011

Annex – Good Practices for Stress Testing
The following practices are adopted by AIs with more robust stress testing program. (a) Segregation of duties is maintained by confining the execution of stress-testing to units independent of the front office. (b) Perform comprehensive stress-testing covering both banking and trading books. This is a recommendation set out in Sections 2.2.4 and 2.2.5 of SPM IC-5 that stress-testing should cover both the trading and banking books with the adoption of an integrated approach and providing results on an institution wide basis. (c) Clearly document the major stress assumptions in the relevant stress-testing policy and / or reports. (d) Adopt a policy requiring management to review the relevance and appropriateness of stress scenarios and parameters at least once a year. (e) Perform stress-testing on movements in foreign exchange rates, parallel and non-parallel yield curve shifts and, where applicable, narrowing of Prime / HIBOR spread for designated management committee’s regular review. In addition, perform stress-test showing the impact on net interest income as a result of a series of adverse stepwise interest rate movements. (f) Perform stress-testing scenarios that simulate previous major crisis situations, such as the 1997 Asian Crisis, the 1998 Russian Crisis and the 2001 U.S. Crisis. In addition, certain AIs perform stress-testing on a hypothetical oil crisis and a hypothetical crisis of major international currencies. (g) Generally perform stress-testing at least once a month, and more frequent stress￾testings, such as on a daily or weekly basis, on more risk sensitive portfolios (e.g. more volatile or highly leveraged products) for risk management unit’s review. (h) Define risk tolerance for stress-testing results with reference to impact on capital adequacy ratio. Excess of pre-set risk tolerance limit requires escalation to senior management for decision on remedial actions. (i) Assess the probability for each stress scenario and present both the gross and expected losses accordingly to management for their information and decision. (j) Present stress-testing results for designated management committees’ review with trend analysis. Trend analysis with proper explanation on large variances improves management’s understanding of an AI’s risk exposures.