On December 11, the UK Financial Services Authority (FSA) published a policy statement entitled “Stress and Scenario Testing.” It outlines the FSA’s policy on stress testing and includes a new “reverse stress testing” requirement.

The strengthened integrated stress testing regime is made up of three main elements:

  • Firms’ own stress testing—The FSA expects firms to develop, implement and action a robust and effective stress testing program (including reverse stress testing) that assesses their ability to meet capital and liquidity requirements in stressed conditions.
  • FSA stress testing of specific firms—As part of its more intrusive supervisory procedures, the FSA runs its own stress tests on a periodic basis for a number of firms, to assess their ability to meet minimum capital levels throughout a stress period. It does this regularly for specific high-impact firms, and for other firms when it is considered necessary.
  • Simultaneous system-wide stress testing—This is carried out by firms using a common scenario for the purposes of specific system-wide analysis for financial stability purposes.

The FSA has set out its view of good practices in stress and scenario testing in an annex to the statement. Firms subject to the new reverse stress testing requirement will have 12 months to implement the new requirements. In the first quarter of 2010, the FSA plans to issue an implementation timetable for firms to submit to the FSA to explain how they plan to incorporate reverse stress testing into their current risk management.

Click here to read the policy statement in full.