While providing comments on the Draft Rules on Stress Testing, banks have sought certain clarifications on these Rules. In addition, they have asked certain interpretation questions. Many such queries/questions have been responded in the final Rules being issued to banks. However, in order to ensure a consistent implementation of these rules, few general questions are answered in the following FAQs.

Q.1: Will SAMA provide standard risk factors and stress scenarios for ensuring consistency in stress testing by banks?

Ans.: The composition and characteristics of portfolios vary from bank to bank and, therefore, every bank is expected to identify risk factors and develop stress scenarios based on the peculiarities of its portfolio. It is not the intention of SAMA Rules to provide standard scenarios to banks for conducting regular stress tests by them. However, as provided under Para 2.1(ii) of the Rules, SAMA may require banks to conduct ad-hoc stress tests from time to time and for this purpose, may specify standard scenarios for conducting such tests to ensure comparability across all banks. The results of such stress tests will also be used as an input for conducting macro stress tests by SAMA.

Q.2: Can banks choose to stress only the main portfolio segments of credit risk (e.g. Corporate and Project Finance) and disregard smaller components (e.g. Retail)?

Ans.: Banks are required to stress test their credit exposures taking into account the nature, size and mix of their portfolio. The ultimate objective is to identify all major risk factors relating to credit portfolio. However, the approach to be adopted for stress testing corporate portfolio may be different from that of consumer and retail portfolio. The stress testing of corporate loans portfolio may involve the assessment of creditworthiness of individual borrowers and then aggregating the impact of risk factors on the portfolio level. The stress tests on consumer and retail loans on the other hand may be conducted on portfolio level given the relatively large number and small value of such loans.

Q.3: Will SAMA provide a covariance matrix of the risk factors and methodologies for multifactor stress testing for use as a common reference by all banks?

Ans.: The methodologies and techniques provided under Para 5 of the Rules are for the guidance of banks and they can adopt any of these and other appropriate techniques in line with their stress testing frameworks. The said Para 5 states that “banks should use appropriate methodologies and techniques for conducting stress tests keeping in view the nature of business activities, size and complexity of operations, and their risk profiles. They may adopt a combination of methodologies and techniques in line with their stress testing frameworks.” The methodologies generally employed in this regard are described under the Rules which include, inter alia, the Scenario Analysis. It is up to the banks to choose appropriate methodologies and techniques in line with their risk profiles and stress testing frameworks. It is not the intention of SAMA Rules to identify relevant risk factors on behalf of the banks. However, SAMA may separately require banks to stress any identified risk factors based on the standard scenarios to be communicated to them as and when deemed appropriate.

Q.4: Do banks need to consider the stress testing effects as at the reporting date, or should they also be applied to the projected figures (as presented in the ICAAP document)?

Ans.: Banks should consider stress testing effects as at the reporting date. The stress scenarios will be applied to the financial statements as of the cut-off dates for reporting of results. However, banks will take into account, inter alia, historical events, prevailing market trends and future outlook in developing the stress scenarios.

Q.5: Given the requirement that banks have to submit the results of their stress testing in the ICAAP, should the template provided in Appendix 1 be separately submitted for the stress test conducted as at 31 December (as the due dates for the ICAAP and this report are the same).

Ans.: Under Para 8 of the Rules, banks are required to reflect the results of stress testing in their ICAAP document. Furthermore, under Para 10 (Regulatory Reporting), banks have to separately submit the results of their stress tests to SAMA on half-yearly basis as per the format attached with the Rules. The reporting under ICAAP is for capital planning purposes whereas the one under Stress Testing Rules is aimed at assessing the effectiveness of stressing testing frameworks developed by banks. Given the differing objectives and scope of both these regulatory reporting, banks are required to ensure compliance of the separate reporting requirements.

Q.6: Is the format for the Statement providing Data for conducting Top- down stress tests the same as the template which is currently provided on a semi-annual basis, or will a new format be prescribed?

Ans.: The format for providing data under Para 10(i) of the Rules will largely be in line with the existing template on which banks are currently providing data on half-yearly basis. However, certain additional data may be requested from time to time given the dynamic nature of the stress testing process. Any future revisions to the data collection template will be communicated by SAMA to banks well in advance.

Q.7: Will SAMA provide banks with the results of any ad-hoc/top-down/macro stress tests conducted by it?

Ans.: SAMA will not formally provide banks with the results of any stress tests conducted by it. However, it may share high level relevant findings with them during bilateral supervisory review meetings, as deemed appropriate.

Q.8: Whether the reverse Stress Testing a mandatory requirement under the Rules or whether this form of test remains optional?

Ans.: Reverse stress testing is a technique widely used to assess the robustness of business plan of a bank. The BCBS “Principles for Sound Stress Testing Practices and Supervision” also require that the stress testing program should include some extreme scenarios which would cause the bank to become insolvent. Thus, conducting reverse stress tests is a mandatory requirement for banks.

Q.9: Can the branches of foreign banks rely on their Group's organizational structure and expertise where the required resources have already been deployed to carry out local stress testing?

Ans.: The concerned branches of foreign banks can seek guidance from their Head Office and rely on their Group’s organizational structure and resources for conducting stress tests locally provided the confidentiality of data and records is duly ensured. Furthermore, they have to maintain proper records of the stress tests so conducted locally and produce them for verification by SAMA as and when required.

Q.10: Can the branches of foreign banks use their Head Office/ Group's stress testing policies/ framework and procedures for conducting stress tests locally?

Ans.: The branches of foreign banks may use their Head Office/ Group's stress testing policies/ framework and procedures for conducting stress tests locally provided such policies and procedures meets all the requirements of SAMA Rules. Furthermore, they should be prepared to provide copies of such policies and procedures to SAMA as and when required by it.