Banks are required to define the magnitude of the shock to be given to each of the identified risk factors separately for the above levels of shocks. They should take into account the following factors in defining the magnitude of the shock:
i.
While determining the magnitude of shock, banks should review the historical pattern of worst events at portfolio level or at the level of specific business segment but this should not be the sole determinant of shock. Other qualitative factors and expert judgment should also guide this process;
ii.
The time horizon for analyzing historical events should cover at-least one business cycle relevant to the underlying portfolio;
iii.
The magnitude of the shock could be more than the worst historical movement in market value of the relevant portfolio but should not be so large or so small to render the stress testing exercise a hypothetical one;
iv.
The magnitude of the shock should also take into account the prevailing market conditions, current operating environment and future perspectives;
v.
The magnitude of the shock should be adequately varied for different levels of shock to assess the vulnerability of the bank under different scenarios;
vi.
The magnitude of the shocks to be applied to the stress scenarios should be determined with reference to the “baseline” scenario and the magnitude for each level of shock should reflect an increasing level of stress when compared with the “baseline” position.
