STRESS TESTING : NEED AND IMPORTANCE

Stress Testing is described as the evaluation of a bank's financial position, under a severe but plausible scenario to assist in decision making within the bank.

- Ravi Mishra

It enables a bank in forward looking assessment of risks, which overcomes the limitations of statistical risk measures or models based on historical data and assumptions. It helps the senior management in understanding the condition of the bank in the stressed time.

Stress testing outputs are used by a bank in decision making process in terms of potential actions like risk mitigation techniques, contingency plans, capital and liquidity management in stressed conditions, etc. It focuses on the impact of credit risk, liquidity risk, market risk etc. in adverse situations both at the bank level and at the systemic level. Stress tests measure the resilience of the individual financial institutions as well as the financial systems as a whole against possible extreme volatilities in the macro economic parameters in any country's financial system.

Stress testing forms an integral part of the internal capital adequacy assessment process (ICAAP), which requires banks to undertake rigorous, forward looking stress testing that identifies severe events or changes in market conditions that could adversely impact the bank. The main objectives of stress testing includes assistance in risk identification and control, complementing other risk management tools, improving capital and liquidity planning, and thereby facilitating the business decision-making. Stress tests plays an important role in the communication of risk within the bank and external communication with supervisors to provide support for internal and regulatory capital adequacy assessments Indian Banks perform the stress tests at least at half yearly intervals.