| 5.5.1 | Banks adopting the IRB Approaches should implement sound stress-testing processes for use in their assessment of capital adequacy. Stress testing should identify possible events or changes in economic conditions that could have unfavorable effects on a banks’ credit exposures, and assess the bank’s ability to withstand such changes. Stress tests conducted by a bank should cover a wide range of external conditions and scenarios, and the sophistication of techniques and stress tests used should be commensurate with the bank’s activities.
|
| 5.5.2 | Described below are some common risk factors that are relevant to and need to be considered in credit risk stress tests:
|
| | • | Counterparty risk characterized by the increase in PDs (e.g. the rise in delinquencies and charge offs) and worsening of credit spreads. Banks should be aware of the major drivers of repayment ability, such as economic/industry downturns and significant market shocks, that will affect entire classes of counterparties or credits;
|
| | • | Concentration risk in terms of the exposures to individual counterparties, industries, market sectors, countries or regions. Banks should assess the contagion effects and possible linkages between different markets, countries and regions as well as the potential vulnerabilities of emerging markets;
|
| | • | Market or price risk arising from adverse changes in asset prices (e.g. equities, bonds and real estate) and their impact on relevant portfolios, markets and collateral values; and
|
| | • | Liquidity risk as a result of the tightening of credit lines and market liquidity under stressed situations.
|
| 5.5.3 | Banks should determine the appropriate assumptions for stress-testing risk factors included in a particular stress scenario, and formulate the stressed conditions based on their own circumstances. In designing stress scenarios, banks should review lessons from history and tailor the events, or develop hypothetical scenarios, to reflect the risks arising from latest market developments.
|
| 5.5.4 | SAMA will consider the results of stress tests conducted by a bank and how these results relate to its capital plans.
|
| 5.5.5 | In addition to the general stress tests described above, banks should conduct a regular credit risk stress tests to assess the effect of certain specific conditions on their total regulatory capital requirements for credit risk. The tests should be meaningful and reasonably conservative. For this purpose, banks should at least consider the effect of mild recession scenarios on their PDs, LGDs and EADs. Where a bank operates in several markets, it need not conduct such a stress test in all of those markets, but it should stress portfolios containing the majority of its total exposures.
|
| 5.5.6 | At a minimum, a mildly stressed scenario chosen by a bank should resemble the economic recession in Saudi Arabia in the past. Banks should assess the impact of this stress scenario based on a one-year time horizon and take into account the lag effect of an economic downturn on their credit exposures.
|
| 5.5.7 | Banks may use either a static or a dynamic test to calculate the impact of the stress scenario1.
|
| 5.5.8 | Where the results of a bank’s stress test indicate a deficiency of the capital calculated based on the IRB Approach (i.e. the capital charge cannot cover the losses based on the stress-testing results), SAMA will discuss this deficiency with the bank’s management. Depending on the circumstances of each case, SAMA will require the bank to reduce its risks and/or to hold additional capital/provisions, so that existing capital resources could cover the minimum capital requirements under the IRB Approach plus the result of a recalculated stress test.
|
| 5.5.9 | Through the review of stress-testing results, regulatory capital could be calculated based on a more forward-looking basis, thereby reducing the impact of rising capital requirements during an economic down turn.
|
