RBI wakes up to the need of Stress Test for banks

New Delhi, June 28: With banks in India beginning to use statistical models to measure and manage risks Reserve Bank of India (RBI) has discovered the relevance of Stress tests.

Globally, banks are increasingly relying on statistical models to measure and manage the financial risks to which they are exposed.

These models are gaining credibility because they provide a framework for identifying, analysing, measuring, communicating and managing these risks.

Since these models cannot incorporate all the possible risk outcomes and are generally not capable of capturing sudden and dramatic changes, banks supplement models with 'stress tests', said RBI in a notification.

Internationally, stress testing has become an integral part of banks' risk management systems and is used to evaluate the potential vulnerability to some unlikely but plausible events or movements in financial variables.

There are two type of stress tests: Sensitivity tests which are normally used to assess the impact of change in one variable (for example, a high magnitude parallel shift in the yield curve, a significant movement in the foreign exchange rates, a large movement in the equity index etc) on the bank's financial position.

The Scenario tests include simultaneous moves in a number of variables (for example, equity prices, oil prices, foreign exchange rates, interest rates, liquidity etc) based on a single event experienced in the past (ie historical scenario for example, natural disasters, stock market crash, depletion of a country's foreign exchange reserves).

It also includes a plausible market event yet to happen (hypothetical scenario - for example, collapse of communication systems across the entire region or country, sudden or prolonged severe economic downturn) and the assessment of their impact on the bank's financial position.

RBI had empasised the need for banks in India to adopt 'stress tests' as a risk management tool in the Annual Policy Statement for 2006-07. Accordingly, the draft guidelines on stress testing were prepared and issued for feedback from banks. On the basis of the feedback received, the draft guidelines have been suitably revised.

RBI will place the guidelines before the Board of Directors at the next meeting for their information and appropriate guidance / advice. Banks shall put in place appropriate stress test policies and the relevant stress test framework for the various risk factors by September 30, 2007.

Banks are required to ensure that their formal stress testing frameworks, which are in accordance with the guidelines in, are operational from March 31, 2008.

UNI