Stress Testing: Synergies with IFRS 9, informing business decision-making and managing multiple regulatory requirements

Stress Testing: Synergies with IFRS 9, informing business decision-making and managing multiple regulatory requirements

Stress testing has been a strong focus since the 2007/2008 financial crisis, and remains a challenging minefield that is evolving year on year to continually increase stability. Stress tests continue to become increasingly challenging with unprecedented scenarios and heightened regulatory expectations. Institutions are balancing an influx of regulatory changes that now need to be accounted for within their stress tests and face an uphill battle to balance compliance with adding value, and moving towards using stress testing as a decision making tool to steer the business.

With The Center for Financial Professionals’ upcoming 5th Annual Stress Testing Europe Summit taking place in late September, we undertook extensive research to explore the key stress testing challenges facing professionals over the coming year throughout the UK and Europe. Some of the main areas that came out from the research were the synergies and interaction between IFRS 9 and stress testing, obtaining the most value out of stress testing and its use to inform strategic decision making and balancing the management of multiple regulatory and jurisdictional requirements. This piece will discuss these areas and following reports will assess other challenges that were prominent throughout the research.

The findings of this research will be illustrated at our 5th Annual Stress Testing Europe Summit, which is taking place on 26-27 September, 2017 in London. The summit brings together 20 presenters and panellists as they share their experiences and ideas to gain value from their investment in stress tests and looking beyond compliance to building a decision making tool.

The agenda can be viewed at:

During the research with some of the industry’s leading practitioners, one of the most prominent areas that continually featured was the interrelation with IFRS 9 and stress testing and utilising both teams for increased efficiency. Both IFRS 9 and stress testing leverage forward looking economic scenarios as their core. Institutions are looking to utilise people and systems to adopt the same scenario generation process for each. There are many synergies seen between IFRS 9 and stress testing people and processes, however there is a fine line to balance in order to manage the two concepts and forecast loan losses under IFRS 9 and stress testing simultaneously. Both requirements need consistency, accuracy and differentiations in processes, therefore complications can rise when bringing the same team to work on each. This presents organisational challenges for the institution with the same teams working on each. Further complications arise when we look forward towards the 2018 EBA stress tests, which is expected to incorporate IFRS 9. As IFRS 9 moves towards the final phase of development and implementation, it is increasingly challenging to manage the two in the final push towards 1st January 2018. Institutions must balance teams to ensure accuracy and efficiency for both projects and look to align the two under a business as usual environment.

Additionally, an ever-present challenge for stress testing teams throughout the industry is complying with regulatory requirements and balancing the management of multiple regulatory and jurisdictional requirements. Be it the PRA Stress Testing in the UK, the EBA stress tests in Europe or CCAR in the US, banks have to deal with a number of regulators that often have differing requirements.  Just from a timing and resource perspective this is a challenge. It takes up a lot of resources to run individual stress tests and create scenarios for one regulator, therefore to do so for multiple regulators and meet multiple requirements is something banks have to contend with.

Something that the industry is starting to see more of is a convergence across regulators, for example many stated that the Bank of England stress tests for 2017 seem to be more in line with the CCAR exercise than in previous years. If this trend does continue it is likely to be beneficial for banks who may only need to maintain one system rather than multiple systems. Currently the infrastructural changes to cater to the differing regulatory requests places an understandably big burden on banks to satisfy regulatory requirements. Whilst in practice it is unrealistic to expect a full convergence across the regulators, more parallels will only lessen the burden and enable more standardised resources, systems and outputs.

A further area that came out of the research was the utilisation of stress testing processes and results for making informed business decisions, to increase the value of stress testing for banks. Much of the thinking over the last year or two has been to move stress testing on from just a regulatory tick boxing exercise. It is a regulatory requirement that must be exercised with extreme precision, however the investment level warrants stronger value than regulatory approval. Therefore institutions are looking to move towards using stress testing to review positions and drive the business forward with a broader understanding of their weaknesses. So how do banks use their stressed outputs to change the behaviour of their organisation or to influence strategic planning? Much of the challenge here is around business education and awareness on what the stress testing process entails, that it is not just a useful mechanism to appease the regulator, but actually provides some useful outputs that can be interpreted for internal purposes. Using these results and outputs to drive the business in a more informed direction should aide in bringing value to the exercise to warrant the resource expenditure. As the industry is more familiar with the process and moves towards a more efficient reporting phase, they can look to expand the stress testing uses and drive their business forward whilst maintaining understanding and management of the risks.

Similarly, institutions are increasingly using stress testing to help in setting their risk appetite. How do institutions use stress testing results more concretely in their risk management and specifically on risk appetite? Stress testing is increasingly being used to help define a banks risk appetite or define the banks risk bearing capability and then using that to dictate the type of business model the banks look to run.

As a whole the main question here seems to be around how banks get the most use and value out of stress testing. There has been a lot of investment into improving stress testing processes and systems over the last few years, too much to accept stress testing purely being used as a regulatory exercise. Therefore banks are looking to gain as much value out of stress testing investment as possible and ensure they keep doing more, better.

These are only a snapshot of some of the challenges that the banking industry is facing with regards to stress testing over the coming months. Over two days the 5th Annual Stress Testing Europe Summit, taking place in London on September 26-27 will review stress testing requirements and the evolving processes as the industry moves towards a more automated approach. Specific focus will be given to IFRS 9 and stress testing, the use of stress testing for informing business decision making, the management of multiple regulatory and jurisdictional requirements, and more. The event brings together a diverse line-up of senior industry professionals boasting a range of institutions to give their insight on evolving stress testing requirements and best practices.

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