The Committee of European Banking Supervisors (CEBS) has just released a public consultation paper, "Stress testing under the supervisory review process", on the proposed application of the supervisory review process regarding the embedding of stress testing in a firm's risk management framework. The CEBS is responsible for agreeing a common understanding on the supervision of the Capital Requirements Directive (CRD), the European Union’s implementation of the New Basel Accord, known as Basel II.
Stress testing, a process used by firms to evaluate the risk embedded in low probability, but potentially high impact, events, is seen by the CEBS as an essential and integral component in the calculation of regulatory capital requirements and they were at pains to point out that it should not be interpreted simply as a top-up process resulting in additional capital being allocated. The CEBS also said that they did not view any particular stress testing methodology or procedure as the correct one and that their view of adequacy in this area would depend on the size and complexity of the firm; the larger the size and the more complex and diverse the activities, the greater the amount and complexity of stress testing that would be expected.
In separate announcements, the Bank of International Settlement (BIS) released two further papers this week in support of the Basel II planning process. "Sound credit risk and valuation for loans" replaces earlier guidance and addresses the common data and processes that may be used for assessing credit risk, accounting for loan impairment and determining regulatory capital requirements. The BIS also released "Supervisory guidance on the use of the fair value option for financial instruments by banks" which addresses bank risk management and capital assessment issues and focuses on the use of the fair value option, and supervisors' evaluation of risk management, controls and capital adequacy.
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