| i. | A Bank must conduct on a regular basis appropriate stress-tests so as to:
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| | a) | Identify sources of potential liquidity strain:
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| | | - | Loss of confidence – justified/unjustified.
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| | | - | Contagion – financial sector weakness, corporate failures, etc.
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| | | - | External factors – market disruption, risk aversion, flight to quality, etc.
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| | | - | Uncorrelated events – operational disruptions, natural disasters, terrorist attacks, etc.
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| | b) | Ensure that current liquidity exposures continue to conform to the liquidity risk tolerance established by that bank's governing body.
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| | c) | Identify the effects on that bank's assumptions about pricing.
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| | d) | Analyse the separate and combined impact of possible future liquidity stresses on its:
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| | | - | Cash flows.
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| | | - | Liquidity position.
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| | | - | Profitability.
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| | | - | Solvency.
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| ii. | A bank must consider the potential impact of institution-specific, market-wide and combined alternative scenarios.
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| iii. | In conducting its stress-testing, a bank should also, where relevant, consider the impact of its chosen stresses on the appropriateness of its assumptions relating to:
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| | - | Correlations between funding markets.
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| | - | The effectiveness of diversification across its chosen sources of funding.
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| | - | Additional margin calls and collateral requirements.
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| | - | Contingent claims, including potential draws on committed lines extended to third parties or to other entities in that bank's group.
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| | - | Liquidity absorbed by off-balance sheet activities.
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| | - | The transferability of liquidity resources.
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| | - | Access to central bank market operations and liquidity facilities.
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| | - | Estimates of future balance sheet growth.
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| | - | The continued availability of market liquidity in a number of currently highly liquid markets.
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| | - | Ability to access secured and unsecured funding (including retail deposits).
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| | - | Currency convertibility.
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| | - | Access to payment or settlement systems on which the bank relies.
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| iv. | A Bank should ensure that the results of its stress-tests are:
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| | - | Reviewed by its senior management.
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| | - | Reported to the bank's Board of Directors or its deleted authority, specifically highlighting any vulnerabilities identified and proposing appropriate remedial action.
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| | - | Reflected in the processes, strategies and systems.
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| | - | Used to develop effective contingency funding plans.
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| | - | Integrated into that bank's business planning process and day-today risk management.
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| | - | Taken into account when setting internal limits for the management of that bank's liquidity risk exposure.
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| v. | Among more qualitative criteria that banks would have to meet before they are permitted to use a models based approach are the followings:
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| | - | Rigorous and comprehensive stress-testing program should be in place.
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| | - | Cover a range of factors that can create extraordinary losses or gains in trading portfolios.
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| | - | Major goals of stress-testing are to evaluate the capacity of the bank’s liquidity to absorb potential large losses and to identify steps the bank can take to reduce its risk and conserve liquidity.
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| | - | Results of stress-testing should be routinely communicated to senior management and periodically, to the bank’s board of directors.
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| vi. | Results of stress-tests should be reflected in the policies and limits set by the management.
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| vii. | Scenarios to be employed:
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| | - | Historical without simulation.
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| | - | Historical with simulation – this means relating to specific profile and idiosyncratic nature of the bank. e.g. if deposits are highly concentrated with top three customers, if one customer goes for an early withdrawal or partial withdrawal, how this simulation would affect historical analysis?
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| | - | Adverse events, based on individual portfolio characteristics of institutions.
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