Basel Committee issues stress-test guidelines

The committee said that the Principles for sound stress testing practices and supervision "address the weaknesses in banks' stress tests that were highlighted by the recent financial crisis."

Nout Wellink, the chairman of the committee and the president of the Netherlands Bank, said that stress testing should be fully integrated in banks' governance frameworks and that the committee will follow up to ensure that these principles are implemented.

Among the recommendations were that banks' stress tests should account for:

· the impact of reduced market liquidity or exposure valuation;

· systemwide interactions and feedback effects;

· views across the organisation;

· a range of perspectives and techniques; and

· scenarios which would challenge the viability of banks (reverse stress tests).

Klaas Knot, the chairman of the committee's risk management and modelling group and division director of supervision policy at the Netherlands Bank, said that the principles were developed with the long-term objective of deepening and strengthening banks' stress testing and supervisory assessment of those practices.

The report recommended that supervisors regularly assess banks' stress tests and, if necessary, challenge the scope and severity of scenarios.

The principles build on the committee's review of industry stress tests before and during the crisis.

The report noted that not only was the crisis far more severe in many respects than was indicated by banks' stress-testing results, but also that it was "possibly compounded" by the tests' fallibility.

The financial crisis had, the report said, highlighted weaknesses in four broad areas: use of stress testing and integration in risk governance; stress-testing methodologies; scenario selection; and stress testing of specific risks and products.

Click here to read the report