Stress testing has become a standard risk management tool for financial institutions. It is being increasingly used as a component of their risk identification and risk management processes. The recent global financial crisis and their impact on financial institutions in many jurisdictions have also highlighted the importance of rigorous stress testing .

SAMA’s review of the Internal Capital Adequacy Assessment Plans(ICAAPs) of Saudi banks has indicated that they have started conducting stress tests but the choice of scenarios and their severity vary from bank to bank. SAMA expects banks to adopt robust techniques and scenarios in line with the best practices to further strengthen their stress testing programs. These Rules are being issued to guide banks in this direction.

Stress tests are conducted by using a set of quantitative techniques to assess the vulnerability of individual financial institutions as well as the financial systems to exceptional but plausible events. The exceptional but plausible events can be defined either against a specific historical scenario or against a hypothetical scenario based on the analysis of past volatility and correlations or by use of other methods. The impact of such events on the profitability and capital adequacy of a financial institution is estimated to assess its capacity to absorb potential losses. The ultimate objective of stress testing is to enable a bank or financial institution to adopt countermeasures that reduce either the probability or the impact of a plausible event to preserve its solvency.

The objective of these Rules is to require banks to adopt robust stress testing techniques and use stress tests as a tool of risk management. The results of stress tests should facilitate the management in making well-informed and timely decisions on strategic planning, risk management and capital planning.

The Rules shall be applicable to all locally incorporated banks licensed and operating in Saudi Arabia. Banks may include their subsidiaries and associates in the scope of stress tests conducted by them if the risks faced by such subsidiaries/associates are material and have bearing on the solvency of the bank. Furthermore, the branches of foreign banks operating in Saudi Arabia are also required to adopt these Rules for conducting stress tests if the size of their total assets is more than 0.5% of total assets of the Saudi Banking System. However, such branches of foreign banks may apply these Rules with such modifications as may be considered expedient keeping in view the size and complexity of their business activities.

SAMA may extend the application of these Rules to any other institution or category of institutions, which are under its supervisory jurisdiction, as may be deemed fit by it from time to time.

These Rules sets out the minimum thresholds to be complied with by banks. However, banks can adopt more sophisticated techniques and scenarios beyond the minimum thresholds specified in these Rules. *In addition, banks would continue to take into account the guidance on stress testing provided by SAMA through its circulars on Basel-II implementation.

*Suggest to provide the circulars on Basel-II implementation. We need to ensure if this is relevant?

These Rules shall come into force with immediate effect. Banks are expected to create appropriate organizational structure and deploy required resources for designing and developing their stress testing frameworks in line with these Rules. Banks are also required to put in place a robust stress testing framework, which fully meets the requirements of these Rules, by 30 June 2012. Furthermore, the information required under Section 10 of these Rules shall be submitted to SAMA starting from the half-year ending 30 June 2012 and for each calendar half- year thereafter, within three months of the end of each half-year.

The Basel Committee on Banking Supervision (BCBS) has issued “Principles for Sound Stress Testing Practices and Supervision” in May 2009. SAMA has circulated these Principles to banks for compliance vide its Circular of 2^nd August 2009. In addition to the requirements of these Rules, banks are also required to take into account the guidance provided in the aforesaid Principles and any other related documents of BCBS in designing, developing and implementing their stress testing programs. In case of any inconsistency in the requirements of these Rules and the BCBS Principles, they should approach SAMA for further guidance.