Ensuring relevance in scenario generation to incorporate a range of scenarios for broader outcomes

Ensuring relevance in scenario generation to incorporate a range of scenarios for broader outcomes

By Andrew Turvey, Head of Treasury Risk & Compliance, Clydesdale Bank

Andrew, can you please tell the Risk Insights readers a little bit about yourself, your experiences and what your current professional focus is?

I have worked in Treasury Risk Management within various UK retail banks for the last 15 years, focusing on liquidity and market risk. My current role is with Clydesdale Bank, the largest full-scope “challenger bank” in the UK. My focus is implementing new ALM and TMS systems, two years on from our demerger from National Australia Bank and preparing for the next challenge, with our planned combination with Virgin Money over the next few years.

What, for you, are the benefits of attending a conference like the ‘Stress Testing Europe Summit’?

Conferences like this are a great way of hearing from other professionals looking at similar risk and compliance challenges but from different business models, different jurisdictions and different organizational cultures. I always learn a lot from attending these conferences and they help to put the challenges we are facing into the broader context.

What are the key considerations to be made when managing finite resources?

It’s always tempting to try to do more and more, particularly when it comes to an area like stress testing: you can always be more sophisticated in your modelling and more thorough in your analysis. However, resources are always finite and we have to be proportionate in the approach we take. For me the two key items are: first, be ruthlessly focused on business impact. Where approximations are used, data is incomplete or there are simplifying assumptions, ensure that the impact is quantified and agreed. Focus on the biggest impact areas that can be managed and de-prioritise the smaller items.

Second, think of it as a journey – a programme of improvements. Ensure that the limitations are understood, clearly communicated and transparent, particularly in governance forums. Drive it forward so that each iteration is better than the previous, with the most impactful limitations addressed first.

In your opinion, what do you think are the main concerns from financial institutions when looking at extreme and tail risks?

I find the biggest challenge getting people to engage in the discussion and framing it correctly. Most people are engaged in “day to day” risks: will I meet my targets this month? Will my investments lose money? These tend to have a relatively short term horizon and cover only a range of reasonably likely outcomes. People understand that they will be held personally accountable for these kinds of risks.

Tail risks are harder. People find it difficult to imagine what could happen in a crisis, particularly one that has never happened before. Persuading people that the scenario is “plausible” as well as “severe” is often the challenge.

In addition, people don’t believe they will be held personally accountable for the consequences of a severe event – a market crash, market closure. The number of times I have heard traders talk about the events of 2007/8 as things that could never have been foreseen or managed – even those that could have been. The key is to persuade people that it’s important to be prepared for everything and get people to see that they can contribute.

How can financial institutions best ensure scenario generation remains relevant to their business?

This is one example of where the drivers of “risk management” and “regulatory compliance” are often misunderstood. If the regulator has asked you to run a particular industry-standard scenario, then clearly this has to be done. However, complying with regulatory requirements will never be sufficient in itself to manage risk. We need to make space for firm-specific risk management actions that address specific vulnerabilities.

The last ten years has seen a whole raft of regulatory requirements impact financial services firms. This has driven resourcing and prioritization and has undoubtedly improved risk management capabilities across the sector. However, the key challenge in the next ten years will be to ensure these are effective and incorporate any firm-specific vulnerabilities.

Over the next 6-12 months what key challenges, concerns and opportunities do you foresee for stress testing professionals?

We are entering a new monetary environment – Quantitative Easing (QE) is being replaced by Quantitative Tightening (QT). Rates are going up, central bank balance sheets are going down and there is generally less liquidity around looking for a home. I see this having an increasing impact on markets in the next 6-12 months – particularly on the higher risk segments. We are already seeing this in emerging markets and I think we will continue to see the impact particularly on the funding of lower-rated financials.

You may also be interested in our Stress Testing Europe Summit…

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