Reverse Stress Test

SUMMARY

The client, a multi-asset bank, who primarily provides execution, clearing and prime brokerage services, requested assistance with the development of the reverse stress.

In order to support the process of the stress test development and its subsequent incorporation in the ICAAP report, Avantage Reply reviewed and assessed the existing approach to the reverse stress test exercise, interpreted relevant regulatory requirements and expectations (such as those stipulated in the FCA Handbook), considered the industry best practices and produced the final document, namely the respective section of the ICAAP report.

THE CHALLENGE

The client belatedly realised that its reverse stress-test scenario for the ICAAP was inadequate and had to develop a new approach in a short period of time.

The overall reverse stress testing methodology had to be revised and enhanced, with special attention paid to the definition of the potential points of failure, identification of the material risks and development of the scenarios and assessment of their severity. Additionally, the reverse stress-test had to be consistent with information provided in other sections of the ICAAP report and with the Wind-Down plan.

APPROACH AND SOLUTION

Avantage Reply provided a team of 2 experts to:

• Review and assess the reverse stress test methodology in place;
• Define the potential points of failure across different dimensions (including capital, liquidity, profitability, etc.);
• Identify the potential catalysts of failure and map them to the material risks;
• Develop the potential stress scenarios, likelihood and severity assessment, and selection of the most adverse scenario based on the analysis performed;
• Write the reverse stress test section of the ICAAP document and ensure its alignment with the Wind-Down plan and other sections of the report

RESULTS AND BENEFITS

The new reverse stress-test approach was developed and adopted in time to submit the ICAAP before the regulatory deadline.