(f) Specific matters relating to stress testing
| (i) | A bank that obtained the approval of the Registrar to adopt the internal models approach for the measurement of the bank's exposure to market risk shall have in place a rigorous and comprehensive programme or process of stress testing— |
| (A) | which programme or process of stress testing— |
| (i) | shall be sufficiently robust to identify events or influences that may have a material impact on the bank's exposure to risk; |
| (ii) | shall form an integral part of the bank's assessment of its capital adequacy; |
| (iii) | shall duly make provision for stress scenarios that cover a range of factors that may cause extraordinary losses or gains in respect of the bank's trading positions and portfolios, or complicate the control of the relevant risks in the said portfolios— |
| (aa) | which factors shall include low probability events in all major types of risk, including the various components of market risk, credit risk and operational risks; |
| (bb) | which stress scenarios shall provide sufficient information relating to the impact of the said events on positions that display linear and/or non-linear price characteristics, that is, options and instruments with option-like characteristics; |
| (iv) | shall be quantitative and qualitative in nature, incorporating, among other things, market risk and liquidity aspects of market disturbances— |
| (aa) | which quantitative criteria shall identify plausible stress scenarios to which the bank may be exposed; |
| (bb) | which qualitative criteria shall include— |
| (i) | an evaluation of the capacity of the bank's capital and reserve funds to absorb potential material losses; |
| (ii) | the identification of steps that the bank can take in order to reduce the bank's exposure to risk, or to conserve capital; |
| (v) | shall be sufficiently robust to combine stress scenarios specified by the Registrar with stress tests developed by the bank in order to reflect the specific risk characteristics of the bank. |
| (B) | the results of which stress testing— |
| (i) | shall routinely be communicated to the bank's senior management and board of directors; |
| (ii) | shall form an integral part of determining and evaluating the bank's management strategy; |
| (iii) | shall be duly documented. |
| (ii) | At the request of the Registrar, the reporting bank shall conduct the tests and provide the information relating to the matters specified below: |
| (A) | Supervisory scenarios not requiring any simulation by the bank For review by the Registrar, a bank shall have available detailed information relating to the largest losses experienced by the bank during a particular reporting period, which information— |
| (i) | may be compared to the level of required and allocated capital and reserve funds calculated in terms of a bank's internal models; |
| (ii) | shall be sufficient to indicate to the Registrar how many days of peak day losses would have been covered by a given value-at-risk estimate. |
| (B) | Scenarios requiring simulation by the bank |
At the request of the Registrar, the reporting bank—
| (i) | shall subject its portfolios to a series of simulated stress scenarios, which scenarios— |
| (aa) | may include a test of the bank's current portfolio against previous periods of significant disturbance, such as the sharp fall in equity markets during 1987 or the 2007/2008 sub-prime and financial market crisis, incorporating large price movements and a sharp reduction in liquidity associated with such events; |
| (bb) | may evaluate the sensitivity of the bank's market risk exposure to changes in the assumptions relating to volatilities and correlations. Application of this test would require an evaluation of the historical range of variation for volatilities and correlations and an evaluation of the bank's current positions against the extreme values associated with the said historical range; |
| (cc) | may include or evaluate such other matters or assumptions as may be specified in writing by the Registrar; |
| (ii) | shall in writing provide to the Registrar the results of the aforesaid simulated stress scenarios, |
Provided that in respect of the aforesaid stress scenarios, the bank shall consider the impact of sharp variations that may have occurred in a matter of days during periods of significant market disturbance in the past. For example, at the height of some of the historic financial market stress events or scenarios, correlations within risk factors approached the extreme values of 1 or -1 for several days.
| (C) | Scenarios developed by the bank in order to capture the specific characteristics of its portfolio |
In addition to the scenarios envisaged in items (A) and (B) above, based on the characteristics of the bank's relevant portfolio, the reporting bank shall develop its own stress tests and scenarios identified by the bank to be most adverse, which scenarios, for example, may include problems experienced in a key region of the world combined with a sharp change in oil prices or prices of other commodities traded in the particular region, provided that—
| (i) | the bank shall in writing provide the Registrar with a description of the methodology used by the bank to identify and conduct the aforesaid scenarios, and a description of the results; |
| (ii) | the results of the aforesaid stress tests and scenarios shall regularly be reviewed by the senior management of the bank and shall be duly reflected in the relevant policies approved and limits set by the bank's senior management and board of directors. |
Provided that when the aforesaid results reveal particular vulnerability to a particular set of circumstances, the bank shall take prompt actions in order to appropriately manage the relevant risks, which actions may include hedging against or reducing the extent of the bank's exposure to market risk.
