Why is ICAAP stress testing such an important topic for the banking industry?

ICAAP, or more generally the assessment of a banks capital requirements into the future, has been part of our industry for quite a few years. It has in fact formed the cornerstone of the Regulators Supervisory Review framework. Capital based measures were (historically pre-crash) based on advanced statistical models (for example Value at Risk) and given their sophistication were generally considered representatives of possible future events. Stress Testing was performed on a regular basis and reported to “Senior Management” but it seems that the message just wasn’t getting through. Now the Regulators are forcing Senior Management to take an interest, both in terms of the standard stress testing, but also by now being embedded into the ICAAP Framework.

If we consider what an ICAAP is for a minute, it isn’t just the “answer” that we are interested in when we do this, it also contains the entire risk framework that the organisation operates under; its policies, its Governance, its methodologies. It is intended to ensure that Senior Management, those that approve this document, understand what is happening in their organisation. Stress Testing, and how it is embedded in their organisation is a key piece of management information that they need to incorporate into their decision making process.

So, why is it so important, and why is it gaining in importance? In my opinion the Regulator has helped our profession by gaining management interest and ensuring that we embed Stress Testing into all aspects of our risk framework, including the ICAAP.

How are banks currently working towards the main objective for ICAAP stress tests?

Banks are trying to address the issue surrounding the embedment of Stress Testing into their ICAAP’s by leveraging off the infrastructure that they have developed for the standard Regulatory Stress Testing. This infrastructure is not just technology based, though a lot of investment has been made in this area. The other areas though are in methodology and governance. There have been significant advances in the way in which we create scenarios, and how we parameterise. These advances have enabled us Risk professionals to be more consistent in our approach and have a better “explanation” capability. This was definitely lacking some years ago. In terms of governance, this is where the real progress has been made, but unfortunately I think we have a lot more to do in this area. Senior Management can rely on the governance of the framework through the organisation. But it is through that organisation that we need to really embed the Stress Testing of our capital.

What are the challenges banks are facing with meeting expectations surrounding ICAAP stress testing?

Well, as I just alluded to, the main challenge I think is in the embedding of the framework into the entire organisation, and not just at the senior management level. If we think about how our organisations work, decisions are being made at all levels. On a trading desk, decisions are made every day which impact our profitability and capital position. It is these areas where we need to reach, to embed the value of stress testing into the daily operations. Technology can help with this, as can governance and methodology, but we have to ensure that the organisation has the right education. Only once this is complete can we say that stress testing is truly embedded.

Do you think the industry is moving towards increased harmonisation between ICAAP and ILAAP?

Most definitely, it makes sense that they become harmonised. Senior Management expects them to be harmonised, just as their management of their organisation is also becoming harmonised. Liquidity is becoming the regulators new “capital” and it is being incorporated into the stress testing and other regulatory lenses. Of course we have the duration issue, in that liquidity stresses (through ILAAP) are shorter term than those for capital, but the linkage to these frameworks and the Recovery Planning is crucial as we all know.

What would you like to achieve by attending the ICAAP Stress Testing and Capital Planning Conference?

I want to discuss the issue of education with my fellow professions and see if they agree with me in that it is one of the key areas of development going forward.