RBS 2010 Annual Report Download - page 127

Stress testing
Stress testing commonly describes the evaluation of a bank’s financial
position under severe but plausible stress scenarios. The term stress
testing is used to refer not only to the application of individual stress tests
but also to the wider economic environment within which these tests are
developed, evaluated and used within the decision making process.
Since the financial crisis of 2008/2009 there has been an increased focus,
both amongst regulators and senior management, on stress testing as a
means of identifying vulnerabilities within a financial institution and within
the financial system as a whole.
Many regulatory documents and initiatives have emerged which require
strong involvement of senior management in the design and evaluation of
scenarios, an emphasis on plausible events and a shift from the
assessment of instant shocks to multi-period analysis of capital adequacy
over a prolonged period of stress.
The Group’s stress testing framework is designed to embed stress testing
as a key risk management technique into mainstream risk reporting,
capital planning and business processes at both the Group and divisional
level.
The Executive Risk Forum is the main body overseeing the stress testing
approach, processes and results. The forum is primarily responsible for
reviewing and challenging the results of any Group-wide stress tests and
ensuring, where necessary, appropriate management actions are initiated.
Industry wide scenarios
RBS has taken part in a number of industry wide stress tests such as an
EU-wide stress testing exercise, the results of which were published in
July 2010.
It is important to note that the tests are theoretical in nature and none of
the data published represent a forecast or prediction by RBS of what
would actually happen in any of the modelled scenarios. Furthermore, the
results are FSA calculations impacting revenues, impairments and
balance sheet items and assume an unchanged balance sheet from the
end of 2009.
The test confirms RBS remains well capitalised with a strong Tier 1
capital ratio under both the benchmark and adverse scenarios.
In addition to the EU stress test, during the second half of 2010 RBS has
undertaken the FSA anchor scenario test.
During 2011, RBS is planning to take part in forthcoming International
Monetary Fund, European Banking Federation and FSA stress testing
exercises.
Other stress testing
In addition to industry wide stress tests, Group standards for stress
testing allow for a combination of various stress testing methods in order
to provide a comprehensive view of the Group’s risk profile. Depending
on the complexity and materiality of the portfolio, techniques may range
from sensitivity analyses performed on an individual product or an
individual portfolio to the evaluation of complex stress scenarios
performed at Group-wide level.
Stress testing techniques applied within the Group are:
xsensitivity analysis;
xscenario analysis; and
xreverse stress testing.
The stress testing programme implemented aims to provide a
comprehensive view of the Group’s risk profile. Stress tests are
performed at the following levels of aggregation:
xfirm-wide level;
xdivision level;
xportfolio level; and
xtransactional or sub-portfolio level.
More details on stress and scenario testing are set out in various sub
sections in the following pages.
125RBS Group 2010
Business review
Risk and balance sheet management