STB Business Partners

FSA Liquidity Stress Testing & Scenario Analysis With STB


FSA prudential requirements include appropriate proactive stress testing of liquidity. At the moment the format this action should take is not defined but is left for firms to interpret according to their internal risk management and regulatory compliance policies.

The FSA do require that a firm:

  • Carry out stress testing and scenario analysis of liquidity needs
  • Put in place contingency funding plans for dealing with a liquidity crisis were it to occur
  • Document its liquidity risk management policy

STB are currently holding discussions with existing clients and other regulated firms to discuss their requirements.

For an informal discussion about your liquidity stress testing requirements, please complete the form on the right.

Stress testing is becoming a significant area of supervisory regulatory interest (with Discussion Paper 05/2 entirely devoted to this). In this DP, the FSA define stress testing to be the impact of the shift of individual parameters, and scenario testing to be the variation of a range of parameters.

In recent times the FSA has surveyed the use of stress testing amongst a range of firms. It was found that a good number of firms had some testing in place, but methods varied, as did the extent to which these tests fitted in with other risk management processes.

Market risk testing is more embedded and Basel II has increased the level of attention to credit and operational risk stress testing, but stress testing of liquidity risks, and of rolled-up group level risks, is not so advanced.

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Comments 

This is a surprising omission, given that an adverse liquidity situation is one of the fundamental risks that arises in banking. It has also quite clearly been the cause of multiple banking failures in the past and will no doubt be in the future. It is the FSA's intention to keep this risk minimised within its jurisdiction.

The FSA has restated a firms' general obligation to embed stress testing in overall risk management processes, and that this is considered good practice.

Prudential Source Book rules include requirements on certain firms (since 31st December 2004, "all deposit takers, insurers and own account dealers have been required to undertake stress tests in relation to liquidity risk").

The FSA intends to work with the industry over the coming quarters to refine their approach.

It can be expected that more specific guidance will emerge, and irrespective of this it can be certain that the minimum standard of liquidity stress testing best practice will increase.

Firms will be expected by the FSA, to be proactively applying stress testing to the issues set out in that guidance, covering both firm-wide and market-wide difficulties.
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