Implementation Model for Stress Tests in the Credit Risk Area

Already in summer 2006, a joint survey by BaFin and the German Bundesbank concluded that: "In the banking sector, there is no common methodology for stress testing in the credit risk area." The main reasons for this lie in the differences in

  • the structures of lending businesses,
  • the definitions of stress test(s) based on institution-specific circumstances and
  • the allocation of responsibilities (for stress tests) within the groups and their subsidiaries.

Identifying stress tests that are relevant for credit risks remains one of the biggest challenges for institutions.

On the basis of this assumption and using macroeconomic scenarios, SKS Advisory has developed a phase model that can be applied to all regulatory portfolios. This model has the following process flows:

After selected portfolio-specific model parameters have been assigned, first of all, a simulation is designed and carried out. Then the required evaluation can be made of the regulatory and economic capital as well as of the P&L.

The SKS stress test implementation model consists of 5 phases:

  1. Portfolio selection and identification of real scenarios with probability of occurrence
  2. Specification of macroeconomic parameters for the scenarios
  3. Allocation of model parameters
  4. Performance of the simulation
  5. Carrying out the evaluation

The diagram below provides an overview of the implementation model.


Requirements for the internal implementation in the credit risk area

Putting the Five Phase Model into practice.

The starting point for the implementation of stress tests should always be a thorough analysis of the strategy. Here, an essential part is a self-assessment with the aim of determining the main vulnerabilities under the business strategy. This will leave the road clear for staking out and specifying both the organisational framework and the responsibilities. An analysis of the simulation capability of all the systems completes the activities of the initial phase. Subsequently, the Five Phase Model is implemented within the scope of four sub-projects: Management & Communication, Scenarios, Simulation Environment & Execution and Evaluation & Reporting.  

The diagram below provides an overview of the main requirements for the internal implementation of stress tests.