An institution “needs to have a strong cross-risk function which coordinates all parties in order to influence the recovery plan,” said Dr. Andrea Burgtorf, Head of Stress Testing, Risk Analytics and Instruments at Deutsche Bank. She was speaking at the GARP webinar on May 21, 2013 about the effect of new regulations on risk management.
As part of the Basel III mandate to develop a Recovery and Resolution Plan, a bank must include analysis of all critical economic functions, and this, said Burgtorf, “forces a bank to examine what are its core and non-core businesses, and to decide which governance bodies must be involved in the recovery plan.”
As part of stress testing, a bank has to simulate various scenarios, with both fast and slow market shocks. The triggers must extend across risk types. “It’s important to engage all bodies within the bank,” she said, noting that Finance, Corporate Planning, and business units must come up with mitigating plans. “People must speak a common language and determine strategies to cope with a crisis and learn to do it faster than before.”
In order to ensure consistency, Burgtorf said that stress testing should be done on the whole institution as well as on sub-portfolios. She clarified that stress testing is not just sensitivity analysis but is something that “gives an economic story.” It’s important to have a strong relationship with the Economics department, because they come up with the numerous parameters that underlie the story. This information is then farmed out to the different risk units. For example, the credit risk people will work with the deterioration in probability of default (PDs) due to the shock in the gross domestic product (GDP) and translate these into a deterioration in credit ratings.
Meanwhile, colleagues in Market Risk work with the oversight committee on how to integrate stress parameters into their view of the world. The stressed market conditions are translated and re-aggregated. “If we hadn’t engaged Economics” as a central component in the stress testing, said Burgtorf, “it wouldn’t be possible.”
The new regulations are involving many people, she said, estimating that 30 to 40 employees are involved in oversight, and about 50 people are connected with it. The Recovery Plan engages 150 to 200 employees in various aspects, although not at the same time.
Burgtorf said that both new regulations and a concern for expense are making institutions break down silos between risk functions. She remarked on the “very strong desire of management to know more about the institution and the combination of different positions.” During a financial crisis, for example, the management must not ignore intra-risk correlation or the diversification effect.
In response to a question from the audience, Burgtorf agreed that reverse stress testing can raise enterprise-wide awareness of the interplay between risks. Reverse stress testing asks, in effect, what will lead to a material drop in capital. It pushes an institution to realize its top risks. “We see it as an instrument to look at the recovery plan or extreme losses. We must look at all aspects: business reduction, expense reduction, and raising capital.” The exercise integrates different types of risk and business units. ª
Go to Part 3. ª
The webinar presentation slides can be found at: http://event.on24.com/r.htm?e=614560&s=1&k=D493202F85CBF2098C216D611906019B>
For a relevant article about “The Hidden Value in Recovery and Resolution Planning” go to: http://www.americanbanker.com/bankthink/the-hidden-value-in-recovery-and-resolution-planning-1055000-1.html