Stress testing has become a fundamental part of the banking industry.
Speaking at the 'Basel III: New Rules for Bankers' seminar, co-organised by Classified Post and Kornerstone, Peter Lam, KPMG director, risk and compliance services, told participants that stress testing was a major component of the new framework.
'In different formats, banks have been using stress-testing analysis for years. However, stress testing as referred to under the new Basel III framework requires a more quantitative approach and methods where assumptions can be evaluated,' Lam said.
For example, stress testing could be linked to changes in a bank's activities if China's economic environment deteriorated or a sovereign debt crisis occurred. 'There is no one-size-fits-all type of stress test and each bank will have its own exposure to different stress parameters,' he said.
Banks could examine the impact of events in all the major macroeconomic variables over the past 10 to 20 years and the likelihood of similar events happening again. Stress testing could also include choosing costly and rare scenarios and then putting them to a valuation model that would look at cost and damage to reputation, he added.
To be effective, scenarios needed to be re-run and re-evaluated on a regular basis to accommodate both changes in a particular bank's asset mix and in future expectations, Lam said. Senior management must also be involved, as they should have a clear picture of the scope of the entire business.