Financial Risk Management: Applications in Market, Credit, Asset and Liability Management and Firmwide Risk

Chapter 9Firmwide Scenario Analysis and Stress Testing

The concept and practice of stress testing has been around for many years in specific risk areas. In the previous chapters of this book we have introduced many methodologies for stress testing and scenario analysis as well as looked at several concrete stress testing examples. While these methodologies are still valid for firmwide scenario analysis and stress testing, special techniques and attentions are called for to successfully achieve the goal of firmwide capital adequacy in forward-looking stress scenarios. The 2007 financial crisis saw a lack of preparation for the liquidity crunch and capital drains in many financial institutions. Perhaps, if banks had worked through different economic scenarios prior to the crisis, they would have been in a better position. Inadequate preparation for crisis can led to systemic risk and severe economic and political turmoil. With the lessons learned from the 2007 financial crisis, regulators are now requiring both quantitative and qualitative methodologies for robust, forward-looking capital-planning processes that account for each bank's unique risks.

In the wake of the 2007 financial crisis, SCAP exercise started in the United States in 2009. Now its successor, CCAR, has become a major focus of the top 25 banks in the United States. CCAR requires bank holding companies with consolidated assets of $50 billion or more to submit annual capital plans to the Federal Reserve for review. ...