The Hindu Business Line : Banks told to do periodic stress tests

`While traditionally stress tests are used in the context of managing market risks, these may also be employed in the management of credit, operational and liquidity funding risks.'

Mumbai , July 3

The Reserve Bank of India has prescribed guidelines to banks for undertaking stress tests.

This follows the suggestion made by the central bank in the policy statement 2006-07 that banks needed to have a robust and sound stress testing process for assessment of capital adequacy.

Stress testing involves identifying possible events, future economic conditions that could unfavourably impact bank's credit exposures and making an assessment of the ability of banks to withstand the loss arising out of such events.

As per the guidelines, banks should put in place a board approved `stress testing framework' to suit their individual risk management requirements.

The framework should factor in aspects such as using stress tests for understanding their risk profile and communicating it to the board and senior management.

This should be used for setting risk limits, allocating capital for various risks and putting in place appropriate contingency plans for meeting situations that may arise under adverse circumstances.

"While traditionally stress tests are used in the context of managing market risks, these may also be employed in the management of credit risks, operational risks and liquidity funding risk," said a circular issued by RBI to banks. Banks should therefore identify their major sources of risk and carry out stress tests appropriate to them.

The guidelines state that banks should identify a range of realistic adverse circumstances and estimate the financial resources needed by it to meet the liabilities as they fall due as well as fulfilling the minimum CRAR requirements.

With respect to the frequency of the tests, RBI suggested that while some tests may be run daily or weekly, some others may be run at monthly or quarterly intervals. However, stress tests should be conducted at least annually and the assumptions underlying them should be reviewed periodically. The documentation of the tests should be preserved at least for five years.

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