It’s only the second year of the Bank of England’s annual concurrent stress test, but already it’s become one of the most significant events in financial services.
The results of this year’s test, released on 1 December, confirmed the progress that the UK’s seven largest banking institutions have made in building their capital positions – all passed the quantitative hurdles set by the regulator, with those firms with significant Asian, emerging markets and trading exposures being most affected.
The results prompted a collective sigh of relief – but I don’t think this is any time for firms to rest on their laurels.
It’s extremely likely that the pass mark for next year’s stress test will be higher and the scenarios set even more severe – so it’s absolutely essential that we learn from this year’s test and prepare for the next.
The BoE continues to focus on the quality of firms’ stress testing processes, as well as the quantitative results. While it recognised that most of the banks tested have made significant progress since 2014 in oversight and governance, data quality and the application of expert judgement, it found a number of weaknesses which will need to be addressed quickly.
The key areas are:
The data quality in net interest income, traded risk and structured finance submissions; the methodologies used to support assumptions and modelling decisions – the BoE felt that quality varied widely and emphasised the importance of having (and clearly documenting) a consistently applied, rigorous framework for setting assumptions; and net interest income projections processes and governance – the BoE also raised this issue last year and said that improvement was needed.
The BoE recognises that it’s a complex process that will take time to address, but its patience will invariably run out at some point.
Now is the time for firms to starting thinking about stress testing not purely as a compliance exercise, but as something that can and should bring business benefits, if managed properly.
Stress testing is just one of several exercises demanded of firms that require strong skills in scenario analysis, risk and finance data management, modelling and management of large volumes of data; recovery planning, ICAAP, ILAAP and strategic decision-making, to name but a few, all use similar resources.
So there’s a strong business case here for alignment – in terms of data, systems, processes, scheduling, and across functions and teams. This not only rationalises the effort involved, but also creates a more joined-up set of outputs.
Stress testing is a huge undertaking which involves enormous investment in terms of time, people and cost. We’ve seen the banks involved invest a lot over the past year in improving their stress testing capabilities but the bar will continue to rise.
It will only become more demanding, financially and operationally – an investment on that scale should surely bring benefits that go far beyond the comfort of compliance.