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    Basel II and Stress Testing: Week - 11

    Uploaded by

    Prince Wamiq
    The document outlines the methodology for stress testing various risks for banks and financial institutions as part of Basel II regulations. It describes how shocks will be applied to foreign exchange rates, credit quality, equity prices, interest rates, and liquidity to assess their impact on capital adequacy ratios. Shocks ranging from 5-15% for foreign exchange, 5-20% for credit quality metrics, 10-40% for equity and interest rates, and 10-30% for liquidity will be applied to evaluate risks.

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    Basel II and Stress Testing: Week - 11

    Uploaded by

    Prince Wamiq
    22 views19 pages
    The document outlines the methodology for stress testing various risks for banks and financial institutions as part of Basel II regulations. It describes how shocks will be applied to foreign exchange rates, credit quality, equity prices, interest rates, and liquidity to assess their impact on capital adequacy ratios. Shocks ranging from 5-15% for foreign exchange, 5-20% for credit quality metrics, 10-40% for equity and interest rates, and 10-30% for liquidity will be applied to evaluate risks.

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    week-11

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    The document outlines the methodology for stress testing various risks for banks and financial institutions as part of Basel II regulations. It describes how shocks will be applied to foreign exchange rates, credit quality, equity prices, interest rates, and liquidity to assess their impact on capital adequacy ratios. Shocks ranging from 5-15% for foreign exchange, 5-20% for credit quality metrics, 10-40% for equity and interest rates, and 10-30% for liquidity will be applied to evaluate risks.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    22 views19 pages

    Basel II and Stress Testing: Week - 11

    Uploaded by

    Prince Wamiq
    The document outlines the methodology for stress testing various risks for banks and financial institutions as part of Basel II regulations. It describes how shocks will be applied to foreign exchange rates, credit quality, equity prices, interest rates, and liquidity to assess their impact on capital adequacy ratios. Shocks ranging from 5-15% for foreign exchange, 5-20% for credit quality metrics, 10-40% for equity and interest rates, and 10-30% for liquidity will be applied to evaluate risks.

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    Basel II and Stress

    Testing
    Week - 11

    Methodology and
    Calibration of Shocks

    Foreign Exchange Risk

    The stress test for exchange rate assesses the impact


    of change in exchange rate on the value of equity

    To model direct foreign exchange risk only the overall


    net open position of the bank/DFI including the onbalance sheet and off-balance sheet exposures shall
    be given an adverse shocks of 5%, 10% and 15% for
    minor, moderate and major levels respectively

    The overall net open position is measured by


    aggregating the sum of net short positions or the
    sum of net long positions; whichever is greater
    regardless of sign

    Methodology and
    Calibration of Shocks

    Foreign Exchange Risk

    For example, the bank may have net long position of


    Rs500 million in Yen, Euro and USD and the net short
    position in GBP and Australian dollar of Rs600 million

    The total exposure will be the greater of the two i.e. sum
    of the short positions of Rs600 million

    The impact of the respective shocks will be calibrated in


    terms of the CAR

    The tax-adjusted loss arising from the shocked position


    will be adjusted from the capital

    The revised CAR will then be calculated after adjusting


    total loss from the risk-weighted assets of the bank/DFI

    Methodology and
    Calibration of Shocks

    Credit Risk

    The stress test for credit risk assesses the


    impact of increase in the level of non-performing
    loans of the bank/DFI. This involves three types
    of shocks:

    The one deals with the increase in the NPLs and


    the respective provisioning. The three scenarios
    shall explain the impact of 5%, 10% and 20%
    increase in the total NPLs directly downgraded to
    loss category having 100% provisioning
    requirement. The tax adjusted impact will be
    calibrated in the CAR of the bank/DFI for each of
    the scenarios

    Methodology and
    Calibration of Shocks

    Credit Risk

    The second deals with the negative shift in the


    NPLs categories and hence the increase in
    respective provisioning. The three scenarios shall
    explain the impact of 50%, 80% and 100%
    downward shift in the NPLs categories. For
    example, for the first level of shock 50% of the
    OAEM shall be categorized under substandard,
    50% of the substandard shall be categorized under
    doubtful and 50% of the doubtful shall be added to
    the loss category. The tax-adjusted impact of the
    increased provisioning will be calibrated in the CAR
    of the bank/DFI for each of the scenarios

    Methodology and
    Calibration of Shocks

    Credit Risk

    The third deals with the fall in the forced sale


    value (FSV) of mortgaged collateral. The
    forced sale values of the collateral shall be
    given shocks of 10%, 20% and 40% decline in
    the forced sale value of mortgaged collateral for
    all the three scenarios respectively. The taxadjusted impact of the additional required
    provision will be calibrated in the CAR for each of
    the scenario.

    Methodology and
    Calibration of Shocks

    Equity Price Risk

    The stress test for equity price risk assesses the


    impact of the fall in the stock market index

    The current market value of all the on balance


    sheet and off balance sheet securities listed on
    the stock exchanges including shares, NIT units,
    mutual funds etc shall be given shocks of 10%,
    20% and 40% fall in their value for all the three
    scenarios respectively

    The impact of resultant loss will be calibrated in


    the CAR

    Methodology and
    Calibration of Shocks

    Liquidity Risk

    The stress test for liquidity risk evaluates the resilience


    of the banks towards the fall in liquid liabilities

    The ratio liquid assets to liquid liabilities shall be


    calculated before and after the shocks by dividing the
    liquid assets with liquid liabilities

    Liquid assets are the assets that are easily and cheaply
    turned into cash

    They include cash and balances with banks, call money


    lending, lending under repo and investment in
    government securities

    Liquid liabilities include the deposits and the borrowings

    Methodology and
    Calibration of Shocks

    Liquidity Risk

    The liquid liabilities should be given shocks of


    10%, 20% and 30% fall

    The equivalent amount should be deducted from


    the liquid assets assuming the fall in liquid
    liabilities is met by the corresponding fall in the
    liquid assets

    The ratio of liquid assets to liquid liabilities shall


    be recalculated under each scenario

    Interest Rate Shocks

    Balance Sheet Duration

    Interest Rate Shocks

    Similarly the weighted average duration of liabilities


    shall be calculated as follows:

    Interest Rate Shocks

    Here the duration of assets exceeds the duration


    of liabilities, which signifies that assets are more
    price sensitive than that of liabilities and certain
    rise in interest rate would cause greater fall in
    the value of assets leading to decline in the
    market value of equity

    A 1-percentage point rise in interest rate would


    cause a fall in its market value of equity by:

    Interest Rate Shocks

    For simplicity, this shock represents a parallel


    upward shift in the yield curve. Now the impact
    shall be calibrated in CAR as follows:

    The change in the MVE shall also be assessed for 2


    and 5 percentage point rise in
    interest rates

    Exchange Rate Shocks

    The impact of change in the exchange rate shall


    be determined by the following procedure:

    For the first level shock of 5% adverse


    movement in exchange rate

    The same procedure shall be followed for 10%


    and 15% hocks to exchange rate

    Credit Shocks

    Increase in NPLs:

    Of the three kinds of credit shocks, the impact of the increase in


    NPLs shall be accounted for as follows

    For the first level shock of 5% increase in NPLs directly


    downgraded to loss category:

    The same procedure shall be followed for 10%


    and 20% increase in NPLs

    Credit Shocks

    Shift in NPLs Categories:

    The impact of shift in 50% NPLs to next


    categories with no change in total NPLs shall be
    accounted for as follows:

    The same procedure shall be followed for 80% and


    100% shift in the NPLs to the respective downward
    category

    Credit Shocks

    Fall in FSV of Mortgaged Collateral:

    The impact of 10% fall in FSV of mortgaged


    collateral shall be calculated as:

    The same procedure shall be followed for 20% and


    40% shocks to FSV of collateral

    Equity Price Shock

    Equity Price Shock:

    The impact of 10% fall in stock market prices


    shall be calculated as:

    The same procedure shall be followed for 20% and


    40% fall in the equity prices

    Liquidity Shock

    Liquidity Shock:

    The ratio of liquid assets to liquid liabilities after


    a 10% fall in the later shall be calculated as:

    The same procedure shall be followed for 20% and


    40% fall in the equity prices

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