STRESS TESTING AND SCENARIO PLANNING FOR DECISION SUPPORT
Unlike the case for unregulated non-financial institutions (FIs), where business, operations and capital allocation plans can generally be made with only notional regard for their effect on tier 1 equity, regulated banks need to coordinate their business planning with their regulatory capital obligations, such as the Internal Capital Adequacy Assessment Process (ICAAP), what you might call the peacetime application of stress testing and scenario planning for business-as-usual (BAU) decision support in cases that fall short of being classified as adverse or severe.
There are at least three key touch points between stress testing and decision support. First, identifying thresholds which represent transitions from BAU to situations requiring management action to implement corrective action or an alternative Plan B (still short of ‘adverse’), based on basic stress or scenario-driven parameters. Related to this are the sensitivities of the various lines of business (LOB), segments, product groups and territories to these parameters.
Second, identifying which levers to pull and how far to pull them to implement corrective action under Plan B, and their impact on provisions and capital reserves.
Third, using formal or robust optimisation techniques to optimise a portfolio structure in support of maximising revenue, margins, profit and return-on-capital, and then stress testing that portfolio to determine related capital requirements and perhaps identifying additional or tighter optimisation constraints to be fed back into the next optimisation iteration.
Jan-Mar 2022 Issue
SAS Institute