Resolution valuations - Where does stress testing come in?
September 27, 2016
Rather than focusing on asset values, stress testing requires banks to demonstrate the impact of alternative economic scenarios on the capital position. This involves modelling the impact on capital resources of factors such as alternative interest rate curves, unemployment forecasts or, in the case of this year's UK stress test scenario recently announced by the BoE, an 8% negative impact on global economic growth.
There is a similarity here to the equity valuation within the valuation Regulatory Technical Standard (RTS), which will be based on forecasts for the bank post-resolution – i.e. not as it is now, but restructured. Some elements of the restructuring may already be obvious (e.g. the sale of non-core assets) but the full restructuring plan cannot necessarily be foreseen prior to resolution. The requirement is to have a dynamic capability such that it is possible to produce forecasts based on a set of assumptions agreed between the bank’s management and the resolution authority.
At the moment, stress testing is a time-consuming process involving manual downloads of data into excel spreadsheets. Investing in more dynamic systems and processes that would make stress testing a more efficient process (with the added benefit of aligning risk and finance) could be costly, but the benefit should outweigh the cost over time as stress testing becomes a recurring requirement and the process could be adapted to meet resolution requirements (I explored this earlier in my blog on stress testing).
There are other benefits to investing. As the banking landscape is changing with the growth of alternative finance and fintech start-ups, banks need to be the masters of their own data and systems, rather than the other way around. Embedding systems and capabilities that better use and understand data can only be a step in the right direction. Being better informed about asset values and the resilience of the income statement would improve business planning and lead to better decision making. If recurring earnings shocks are avoided, banks will start to win back the confidence of shareholders, investors, regulators and, perhaps most importantly, customers.
Coordinating data and systems
Data and systems are only going to increase in their importance to banks. Taking a more coordinated approach could help banks deal with regulatory requirements (such as resolution valuations and stress testing) more efficiently and it may even help them carve out a strategic advantage.
Find out how to save money (by investing more in IFRS 9 now) when resolution valuations need to be embedded here.
Get in touch if you’d like advice on the approach you’re taking to stress testing and other regulatory requirements. Or share your thoughts in the comments box below.