The FSA has published Policy Statement 09/20: Stress and Scenario Testing - feedback on CP08/24 and final rules (PS09/20).

The FSA’s integrated approach to stress testing consists of three main elements:

  • Firms' own stress testing. The FSA expects firms to develop, implement and action a robust and effective stress testing programme which assesses their ability to meet capital and liquidity requirements in stressed conditions, as a key component of effective risk management.
  • FSA stress testing of specific firms. As part of its more intrusive supervisory approach the FSA runs its own stress tests on a periodic basis for a number of firms. This is carried out regularly for specific high impact firms and for other firms as the need arises, to assess their ability to meet minimum specified capital levels throughout a stress period.
  • Simultaneous system-wide stress testing. This is undertaken by firms using a common scenario for the purposes of specific system-wide analysis for financial stability purposes.

The above elements are interlinked and mutually reinforcing. In PS09/20 the FSA focuses primarily on improvements it expects to see in firms’ own stress testing - the first element above.

In PS09/20 the FSA reports on the main points arising from the responses to Consultation Paper 08/24: Stress and scenario testing - feedback on CP08/24 and final rules. In particular the FSA provides detailed comments on the following:

  • Stress testing infrastructure. The FSA reminds firms about the importance that they establish, implement and action an effective stress testing programme. Annex 3 of PS09/20 sets out good practice.
  • Pillar 2 stress testing. The FSA describes its expectations for the appropriate severity of Pillar 2 stress scenarios.
  • Reverse stress testing. The FSA introduces reverse stress-testing requirements for firms to identify and assess scenarios most likely to cause their current business models to become unviable.
  • Specific concerns from insurers. In Annex 4 of PS09/20 the FSA addresses a range of issues relating to insurers’ stress testing, to assist their understanding of the FSA’s requirements, and in particular, the capital planning stress test.

The FSA has also published a short Consultation Paper, Consultation Paper 09/30: Capital planning buffers (CP09/30). A capital planning buffer (CPB) is the amount of capital that a firm should hold so that it is available to absorb losses and meet higher capital requirements in adverse external circumstances such as an economic downturn. In CP09/30 the FSA consults on simplifying its approach and provides further clarification about the expectations on the use of the CPB and the mechanism by which firms can draw down the buffer. The FSA sees the consultation as an initial step in improving firm’s capital ahead of international discussions which will take place in 2010. The deadline for comments on CP09/30 is 31 March 2010.

View Policy Statement 09/20: Stress and Scenario Testing - feedback on CP08/24 and final rules, 11 December 2009

View Consultation Paper 09/30: Capital Planning Buffers, 11 December 2009