Page 42 - Banking Finance April 2022

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proper MIS in place and ensure maintaining proper When the stress tests are not favourable for
infrastructure. financial institutions then following scenarios

There are broadly two categories of stress tests used in occurs:
banks namely sensitivity tests and scenario tests. Sensitivity Y No Dividend payment to their shareholders
analysis estimates the impact on a bank's financial position Y High plough back of profit and thereby shore-up their
due to predefined movements in a single risk factor like net worth
interest rate, foreign exchange rate or equity prices, shift
in probabilities of defaults. In the sensitivity analysis, the In case of failed stress tests for banks/FI following
source of the shock on risk factors is not identified and
usually, the underlying relationship between different risk scenarios occur:
factors or correlation is not considered. Y Rework their business plan
Y Restructure their assets portfolio
Scenario Analysis seeks to assess the potential consequences
for a firm of an extreme but possible state of the world. This Y Do the stress tests in a simulated environment
analysis is based on a historical event or hypothetical event. Y Resubmit the results of the revised stress tests.
Scenario analysis is currently the leading stress testing
technique. The banks identify relevant risk drivers. And RBI has time to time laid stress on Stress Testing as it
subsequently the banks stress the identified risk drivers using consider market illiquidity and the interplay of market and
different degree of severity. credit risk. Due to outbreak of Corona pandemic in the year
2020 and to judge the impact of it on banks/NBFCs RBI in
There is also a concept of Reverse stress testing which is a June 2020 , advised all banks and NBFCs to do Covid stress
technique that involves assuming worst stressed outcome tests and analyse the impact on balance sheet, asset quality,
and tracing the extreme event/shocks that bring the liquidity, profitability and capital adequacy for FY21 and FY22
maximum impact. Reverse stress testing starts from an and based on the outcome of such stress testing, banks and
outcome of business failure and identifies circumstances NBFCs have been advised to work out possible mitigating
where this might occur. It is seen as one of the risk measures including capital planning, capital raising, and
management tools usefully complementing the "usual" contingency liquidity planning.
stress testing, which examines outcomes of predetermined
scenarios. For the classification of banks for stress testing, This year also RBI may asks bank to perform the stress tests
banks have been classified into 3 groups as below: to judge the impact of second phase of COVID 19 . In its
Group A - Bank with Total Risk Weighted Assets(RWA) of Financial stability report released on 11 January 2021 , RBI
more than Rs.2000 billion
said gross NPAs could rise to 13.5% under the baseline stress
Group B - Bank with Total Risk Weighted Assets between scenario by 30 September 2021, the highest in more than 22
Rs.500 billion and Rs.2000 billion years, up from 7.5% as of 30 September 2020. It is predicted
Group C - Bank with Total Risk Weighted Assets less than to almost double to 14.8% under a severe stress scenario.
Rs.500 billion Hence Regulator is now looking for multiple indicators like
credit disbursement, adoption of information technology
A bank that falls under Group A should carry on stress testing across banks etc. for the comprehensive stress tests.
programmes with all the complexities and severities
required for programmes to be realistic and meaningful. A Hence we see that stress tests has a great importance . It
bank that falls under Group B, conduct multifactor sensitivity helps not only in managing funding risk taking into
analysis and simple scenario analyses of the portfolios with consideration all relevant market rates but also produce
respect to simultaneous movements in multiple risk factors information summarizing the bank's exposure to extreme
caused by an event. A bank that falls under Group C conduct but possible circumstances.
simple sensitivity analyses of the specific risk types to which
it is most exposed. This will allow such bank to identify, Reference:
assess and test its resilience to shocks relating to the 1. RBI site
material risks to which its portfolios are exposed. 2. Economic news from newspapers, internet etc.

42 | 2022 | APRIL | BANKING FINANCE