The Basel Committee on Banking Supervision today issued the consultative paper Principles for Sound Stress Testing Practices and Supervision

The paper presents sound principles for the governance, design and implementation of stress testing programmes at banks. It addresses weaknesses in stress testing exposed by the financial crisis.

These include the underestimation of the potential severity and duration of stress events and the insufficient identification and aggregation of risks on a firm-wide basis.

The paper sets expectations for the role and responsibilities of supervisors in reviewing firms’ stress testing practices and emphasises that a sound stress testing program should be directed by the board and senior management, provide forward-looking assessments of risk, complement information from models and historical data, be an integral part of capital and liquidity planning,  guide the setting of a bank’s risk tolerance, and facilitate the development of risk mitigation or contingency plans across a range of stressed conditions.

Nout Wellink, chairman of the Basel Committee on Banking Supervision and president of the Netherlands Bank, noted that “stress testing is an important risk management tool. It plays a critical role in strengthening not only bank corporate governance but also the resilience of individual banks and the financial system.”

He added that “the financial crisis has demonstrated the importance of stress testing as an integral part of any bank’s risk management, liquidity and capital planning process”.

The consultative paper responds to one of the key risk management actions required by the G20 leaders in their Nov 15 Declaration of the Summit on Financial Markets and the World Economy. Comments on the paper should be submitted by March 13.

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