Building effective stress testing framework and robust forecasting process

Building effective stress testing framework and robust forecasting process

Evgueni, can you please tell the Center for Financial Professionals readers about yourself and your professional experience?
I spent most of my professional career in risk management. I worked in several large banks like Lloyds Banking Group, HSBC, ING Group and BBL (Banque Bruxelles Lambert) where my areas of responsibilities were various risk management areas like stress testing including regulatory stress tests (e.g. UK industry wide stress test, reverse stress test, EBA stress test), risk appetite, capital management, portfolio risk optimisation and risk modelling and analytics. Since 2011, I has been a Chairman of the European Risk Management Council – a think tank of Chief Risk Officers and risk executives from banks, insurances, asset management firms and other financial institutions operating in Europe. In 2013, I published Heads or Tails: Financial Disaster, Risk Management and Survival Strategy in the World of Extreme Risk – a book dedicated to the tail risk management.
I also spent some time in academia. Currently I am a visiting Professor of Cass Business School (City University, London) and before was a visiting Professor of International Economics at the Boston University and a visiting Professor of Money, Banking and Credit at the United Business Institutes in Brussels.
We are looking forward to you presenting at our Stress Testing Europe summit where you will be discussing the building of an effective stress testing framework and robust forecasting process. Why do you feel this is a key talking point?
I am convinced that stress testing is one of the most effective risk management tools that we currently have. However, not always we use it in full capacity. In reality, in most of cases we don’t use the stress test properly. Quite often, we even misuse it. Substantial increase of stress testing efficiency is a task of high importance. And this task is quite achievable. Today majority of financial institutions already have their stress testing programmes and stress testing infrastructures in place and dedicated specialists that run stress tests on regular basis. In order to increase an efficiency of stress testing, we need to improve a process of stress scenario generation and selection, to make the scenario analysis process more robust and to remove a conflict of interest from stress testing governance. All these changes are not about extra investments, headcounts and costs. This is all about doing things right.  All these improvements can dramatically increase stress testing added value.
Can you explain some of the benefits of using the right stress testing and scenario analysis tools?
Benefits are very tangible. Firstly, the right stress testing process allows a selection of most appropriate from risk management perspective stress scenarios. It can save a lot of scarce resources and time. We will be able to run more scenarios that are really matter for the organization. Secondly, using the right stress testing process and scenario analysis tools allow producing a realistic and reliable stress testing results. This is exactly what regulators and senior management expect from stress testing. And thirdly, using the right stress testing process a firm will be able to create a credible contingency plan to mitigate the stress scenario’ risks. In fact, from risk management perspective a mitigating action plan is the most valuable outcome of the whole stress testing process as it helps a firm to avoid a disaster if a stress scenario unfolds in the real life.
How do you see the role of the stress testing professional changing over the next 6-12 months?
The role of stress testing in the financial sector has been constantly increasing in the last 5-8 years. I expect that this trend will remain. Moreover, I expect that demand for stress testing will even accelerate in the near future. One of the reasons is Brexit. The outcome of the EU referendum has already created unprecedented economic and political changes in the UK. In the next two years, the UK and the EU will be travelling through the unchartered territory of Brexit. This will substantially increase uncertainty for the financial sector and will make decision making processes much more difficult. So decision makers of different levels (e.g. senior leaders of private businesses, regulators, investors, politicians) will require to analyse multiple potential scenarios as Brexit process starts evolving. Any economic and political turbulence (which is quite likely during the Brexit negotiation period) will make demand for stress testing even higher.
The ability to run different scenarios very quickly (in few days or even hours) and generate a mitigating action plans will become a crucial for stress testing specialists. Therefore, the stress testing will become less “academic” (“we need to run stress testing because this is perceived a good industry practice”) but more business necessity (“we need this stress test in order to make our business decisions”). This will help business to increases its chance to successfully avoid extreme risks and thrive in the post-Brexit era.

1 Comment

  1. Tally Ferguson says:

    These Risk Insight articles are interesting, timely and well written. Best use of my linked in time in months.

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