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GUIDING PRINCIPLES ON STRESS TESTING FOR INSTITUTIONS OFFERING ISLAMIC FINANCIAL SERVICES [OTHER THAN ISLAMIC INSURANCE (TAKĀFUL) INSTITUTIONS
AND ISLAMIC COLLECTIVE INVESTMENT SCHEMES]
PUBLIC COMMENTS RECEIVED IN RESPECT OF EXPOSURE DRAFT ON ED-13
Feb 03, 2012 [V.3]
7th Meeting of Stress Testing Working Group (STWG) 31st January 2012
Kuala Lumpur, Malaysia
Confidential. This document must not be, in whole or in part, reproduced or used for any other purpose, or shown, given, copied to or filed with any other person other than a member of the STWG and/or Technical Committee without the written consent from the IFSB.
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TABLE OF CONTENTS
PARTIES FROM WHOM WRITTEN RESPONSES WERE RECEIVED ........................................ 3
LIST OF COMMENTS..................................................................................................................... 6
GENERAL COMMENTS (WITHOUT SPECIFYING ANY PARAGRAPHS)................................. 6 SECTION 1: INTRODUCTION AND BACKGROUND ............................................................... 32 SECTION 2: NECESSARY CONDITIONS FOR AN EFFECTIVE STRESS TESTING REGIME................................................................................................................................................... 42 SECTION 3: GUIDING PRINCIPLES ON STRESS TESTING FOR IIFS .................................. 46 SECTION 4: GUIDING PRINCIPLES ON STRESS TESTING FOR SUPERVISORY AUTHORITIES......................................................................................................................... 126 DEFINITIONS.......................................................................................................................... 138
Some words of encouragement ……. “The Guiding Principles that have been laid out for national regulators are crucial for monitoring of the safety and soundness of the individual IIFS as well as identifying the weakness in the financial system. The PIDM commends IFSB’s effort and fully support its role in promoting soundness and stability of IIFS”.
Perbadanan Insurans Deposit Malaysia (PIDM) ... “We welcome the efforts of the IFSB to create a level playing field for Islamic business”.
Saudi Arabian Monetary Agency ..“We appreciate your efforts in developing and enhancing the Islamic financial services”
Central Bank of Jordan
…. “The Guiding Principles appear very useful for conducting appropriate stress tests in view of fostering market confidence with regards to the soundness and stability of IIFS and the Islamic financial services industry as a whole”.
Banque Centrale Du Luxembourg ….“Overall, we consider the Exposure Draft (ED) to be of a high quality, comprehensive and with clear guiding principles for IFIs”.
Islamic Development Bank …. “The Guiding Principles contain high level governance principles for stress testing, with which we are in agreement and feel that they will create the market discipline needed for these functions to be effective”…
Arcapita Bank, Bahrain …..“The IFSB has done an excellent work in developing a very comprehensive Guiding Principles on Stress Testing taking into considerations the additional areas that are only peculiar to Islamic [finance] such as Shari’ah non-compliance and the various underlying Islamic contracts used in the industry”…
OCBC Al-Amin, Malaysia
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PARTIES FROM WHOM WRITTEN RESPONSES WERE RECEIVED Organisations
I# Name of Organisation (Acronym) Country
1. Al Salam Bank Bahrain ASBB Bahrain
2. Arcapita Bank ACB Bahrain
3. Capinnova Investment Bank CIB Bahrain
4. Central Bank of Bahrain CBB Bahrain
5. First Energy Bank FEB Bahrain
6. Ithmaar Bank ITB Bahrain
7. International Investment Bank IIB Bahrain
8. Kuwait Finance House Bahrain KFHB Bahrain
9. Khaleeji Commercial Bank KHCB Bahrain
10. Sakana Holistic Housing Solutions SHH Bahrain
11. Bangladesh Bank BB Bangladesh
12. Central Bank of Egypt CBE Egypt
13. Hong Kong Monetary Authority HKMA Hong Kong
14. Hong Kong Associations of Banks HKAB Hong Kong
15. Bank Indonesia BI Indonesia
16. Securities and Exchange Organization of Iran SEO Iran
17. Central Bank of Jordan CBJ Jordan
18. Central Bank of Kuwait CBK Kuwait
19. Warba Bank WB Kuwait
20. Ahli United AU Kuwait
21. Kuwait International Bank KIB Kuwait
22. Kuwait Finance House KFHK Kuwait
23. Boubyan Bank BB Kuwait
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24. Islamic Development Bank IDB KSA
25. Saudi Arabian Monetary Agency SAMA KSA
26. Al Baraka Bank SAL ABL Lebanon
27. Banque du Liban BDL Lebanon
28. Banque Centrale Du Luxembourg BCDL Luxembourg
29. Alliance Islamic Bank ALIB Malaysia
30. Asian Finance Bank AFB Malaysia
31. AmIslamic Bank AIB Malaysia
32. Bank Negara Malaysia BNM Malaysia
33. Bank Rakyat Malaysia Berhad BRM Malaysia
34. Bank Pembangunan Malaysia Berhad BPMB Malaysia
35. Bank Muamalat Malaysia Berhad BMMB Malaysia
36. IBH Investment Bank IBH Malaysia
37. Kuwait Finance House Malaysia KFHM Malaysia
38. OCBC Al-Amin Bank OCBCA Malaysia
39. Perbadanan Insurans Deposit Malaysia (Malaysia Deposit Insurance Corporation)
PIDM Malaysia
40. Securities Commission Malaysia SCM Malaysia
41. Standard Chartered Saadiq Berhad SCS Malaysia
42. Maybank Malaysia MBM Malaysia
43. Hong Leong Islamic Bank HLIB Malaysia
44. Alrajhi Bank Malaysia ARBM Malaysia
45. Bank Al-Maghrib BKAM Morocco
46. Central Bank of Nigeria CBN Nigeria
47. Al Baraka Bank (Pakistan) Limited ABP Pakistan
48. Bank Alflah Pakistan BAP Pakistan
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49. Burj Bank Pakistan BBP Pakistan
50. Asian Development Bank ADB Philippines
51. Bangko Sentral Ng Pilipinas BSNP Philippines
52. Masraf Al Rayan MAR Qatar
53. Qatar International Islamic Bank QIIB Qatar
54. Central Bank of Sudan CBOS Sudan
55. Central Bank of the Republic of Turkey CBRT Turkey
56. Dubai Financial Services Authority DFSA UAE
57. Dubai Islamic Bank DIB UAE
58. International Monetary Fund IMF USA
(Based on alphabetical order of organization’s country)
Individuals
# Name and Organisation (Acronym)
59. Andrew Cunningham, Darien Middle East, UK Andrew
60. Dr. Murat Ünal, Funds@Work AG, Germany Murat
61. Wan Hanif Wan Muhammad, Group Internal Audit Department of the IDB Wan
*Note: Notwithstanding the above list, the following pages of this compilation focus only on written comments that suggest specific changes/amendments to the ED. Hence, readers may find that for written comments which compliment the ED without suggesting any specific changes/amendments to the drafting structures, such as those received from ASBB, AFB, ADB, BDL, BCDL, BKAM, BB, CIB, CBE, CBK, CBJ, DFSA, FEB, IBH, QIIB, SEO, and SHH, there is no mention of or reference to them in the following pages of this compilation. **Note: The column one in the list of comments indicates reference to the ED (which was exposed for public consultation) made by the respondents and the column two lists feedback/comments of the respondents. However, the last column indicates IFSB response and references to revised ED, and therefore, the reference to revised ED will differ with ED given the changes introduced based on the feedback.
List of Comments
# Subject Matter/Reference
Issues/Comments Received
IFSB Response/
Recommendations
GENERAL COMMENTS (WITHOUT SPECIFYING ANY PARAGRAPHS) 1.
Principles based Approach, Proportionality and specific issues in IIFS
PIDM welcomes the approach based on guiding principles and supports a proportionate approach where the required degree of sophistication of stress testing programme should reflect the relative sophistication in risk and business profiles of the IIFS. PIDM
No change. Noted.
2.
Islamic banking concepts and Arabic terms
The authors assume that all readers understand Islamic banking concepts and Arabic terms but we do not despite the definition list at the end, so our comments focus on generic stress testing issues. IMF
No change. It is not the objective of this ED to explain and define what specificities of Islamic banking concepts and Arabic terms are, rather provide guidance on the applicability of these concepts/terms with respect to stress testing at IIFS. Therefore, one should refer to other IFSB standards for the explanation of these concepts. In this regard, for the purpose of completeness, the ED has made several cross-references to other IFSB standards for these concepts, and explanation in the definition list at the end of the ED.
3.
To clearly differentiate the use of
Through out the ED, use of stress test scenarios,
No change. This is not possible to
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the terminology scenarios, risk drivers and process
risk drivers and process (i.e., things to look out for) have been jumbled up without clarity of the context. Suggest defining these terminologies including its use in respective stage in the stress testing process. BNM
explain each terminology in the ED as these terminologies are well understood by IIFS and supervisory authorities as shown in the Survey. Further, the systematic flow of Guiding Principles has provided greater clarity to the IIFS and others. For instance, the ED does not move to discuss scenarios before discussing the risk factors and risk drivers. Whereas process refers to whole stress testing programme with respect to each component, which is well understandable.
4.
Time horizon for stress test
Suggest including a requirement or clarification on the time horizon a stress testing should be conducted. The stress testing time horizon should consider the type of risk and the purpose of the stress testing. BNM
No change. This has already been addressed under Principle 3.20 (i.e. frequency of stress testing). The opening paragraph makes it very clear that in order for stress testing to be a meaningful part of the risk management framework, stress tests should be undertaken with appropriate frequency in the light of the nature of the risks to which the IIFS are exposed and the types of tests performed.
5.
Frequency of stress testing
Although the guiding principles are there for use of multiple stressing scenarios, however, the frequency of simultaneous multiple stress scenarios may be set different from the regular stress testing for example it may be set to be annual instead of bi-annual or quarterly. ABP
No change. This issue has already been addressed under Principle 3.20 (i.e. frequency of stress testing). See also above.
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6.
Stress Testing framework
A sophisticated Stress Testing framework specifically designed for Shari’ah-compliant products and services of IIFS will be a major task for smaller banks, as this will consume enormous resources and will require large investments. SAMA
No change. It is already been recognised in the ED that these costs may seem high for some IIFS, particularly small or medium-sized ones. However, the costs must be weighed against the potential loss mitigation, the value of the information and risk control gained, and the capital management that will result from an effective, well-designed stress testing programme. Such a programme would enable the IIFS to better understand its risk profile, improve its portfolio management practices, and avoid making costly errors in credit decisions in the future by modifying key practices and improving risk identification.
7.
Acronyms – [IIFS] Institutions offering Islamic financial services in banking segments (which, for the purpose of this document only, shall also include Islamic windows operations) [other than Islamic insurance (Takāful) institutions and Islamic collective investment schemes]
According to Paragraph 11 of ED13, the Guiding Principles in general do not apply to Islamic window operations. However, the acronyms for “IIFS” contains the wording “include Islamic windows operations”. The IFSB may wish to refine the acronym to avoid confusion. HKMA
Agreed. This acronym is refined to avoid confusion as suggested by the HKMA.
8.
Large state ownership of banks in the region
Any issues arising from the large state ownership of banks in the region? IMF
Agreed. The Paragraph 163 under Principle 4.3 has been updated. This critical factor should be part of the factors which are outlined in the Paragraph 163 under Principle 4.3. The IFSB believes that issues related to large state ownership in a particular
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region are important on the functionality of stress testing exercise across the system; however, the IFSB also understands that this will be tackled at respective supervisory authority level.
9.
How to consider/embed correlations? What are scenarios?
We believe that IIFS would be more interested in knowing the followings along with examples: • More specifically defined/recommended stress
scenarios, their severity and other possible specific assumptions;
• how to aggregate the effects of specific and market wide, Micro- and Macro- stress events on IIFS corporate level;
• How to consider/embed correlations among risk factors when performing scenario analysis;
• Any recommended sources for past data/figures, correlations.
IDB
No change. It is outside the scope of this ED and the IFSB to define or recommend any particular stress scenario and how to consider correlations among risk factors, and recommend sources of data for any IIFS. This should be done within IIFS and management of the IIFS should address these concerns and specifically data limitation (see also Section 2.2). In regard, how to apply the Guiding Principles contained in the ED, this is one of the issues which the IFSB may consider addressing in detail through “implementation guidance” that can cover illustrations on how to perform stress testing through different approaches.
10.
Practicability of the document
I am a little concerned that the document may be too detailed for some supervisors, or even banks, to digest. For example, the guidance on ICAAP provided to banks by the U.K.’s Financial Services Authority (“ICAAP Submission – suggested formal”) runs to only eight pages. Publishing documents which are authoritative should of course be a central feature of the IFSB’s work, but I wonder whether some thought could be given to facilitating
No change. Noted. This is one of the issues which the IFSB may consider addressing in detail through “implementation guidance” that will cover operationalisation of the Principles, check lists, and illustrations of how to perform stress testing through different approaches and their impacts.
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the implementation of such documents, both by supervisors and banks. For example, a stress testing checklist – of one or two pages – may give both supervisors and banks an easy entry point into what is necessarily a complex and detailed exercise. Such an initiative would also enable to IFSB to use its position as a supra-national body to standardize basic approaches to stress testing across the Shair’ah-compliant landscape. Andrew
11.
Provide IIFS with a detailed framework covering all the guiding principles
We recommend IFSB to provide IIFS with a detailed framework covering all the guiding principles highlighted in subject document which would enable IIFS to comply with the implementation date of January 2013. The absence of such detailed framework may lead to inappropriate application of these guiding principles across the IIFS levels. AU
No change. The ED is already detailed and comprehensive, and detailed and specific framework is expected to be provided to the IIFS by respective supervisory authority. With respect to implementation guidance, please see response in (9) and (10) above respectively.
12.
Methodology to conduct its stress testing
Islamic Banks in Kuwait has been undertaking stress testing based on the Instruction (No. 2/RBS/44/2009) from the Central Bank of Kuwait in this regard. Based on the same, KIB while preparing its methodology to conduct its stress testing had adhered to the CBK requirement in this regard as well as used the best practice principles on stress testing as prescribed by the BIS. KIB
No change. Noted.
13.
Stress testing Guiding Principles are very comprehensive and the related expectations are over …..country-specific interpretations
As a general comment, the proposed guiding principles on stress testing are very comprehensive and the related expectations are over and above those placed on non-Islamic banking institutions.
No change. Providing an execution tool to allow for consistent, practical implementation across the industry/country is not the main intent
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These comprehensive principles could be accompanied by an execution tool to allow for consistent, practical implementation across the industry/country. In the Malaysian context, the Islamic banking industry may, in general, face challenges in meeting all the recommendations as most of the institutions are leveraging on expertise from their parent, non-Islamic banking institution and inconsistent expectations may be difficult to execute. Additionally, having different stress testing practices would result in complications when consolidating the results to obtain a “bank-wide” view. There may also be country-specific interpretations that need to be aligned first, prior to rolling-out a comprehensive industry-wide stress testing policy. By way of example, the Malaysian Islamic banking industry treats Mudarabah funding as liability, whereas the proposed guiding principles interprets it as investment accounts. SCS
of the Guiding Principles rather that is left to the IIFS and in order to enhance the consistent and practical implementation, the role of supervisory authorities is significant. It is expected that respective supervisory authorities will ensure that the implementation of the Guiding Principles has taken into account the local context (i.e. country-specific legal, regulatory considerations) and concept of proportionality as also discussed in the document. In addition, this is a matter of the value of alpha, which is addressed separately in IFSB GN-4.
14.
Several MIS reports covering stress Testing
The system/Modules selected by Islamic Institutions should carry the similar dimensions to bring in uniformity and clarity in Operations. Under the present scenario at Bank Alfalah we produce several MIS reports covering stress Testing and Liquidity on daily, weekly, Monthly, Quarterly basis for Senior Managements including RMD’s review and any change is highlighted and brought to their notice to seek advice. BAP
No change. Noted.
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15.
Factors that may be put before the implementation of these principles.
Further, the application of these guidelines is dependent on the following factors that may be put before the implementation of these principles.
1- Close coordination between regulators, IIFS and IFSB to come up with a strategy in implementing these guidelines in stages i.e. simple, intermediate and advance approaches.
a. This will help in understanding the issues
faces by IIFS in gathering the data b. This will help regulators in better controls on
IIFS c. This will help IFSB in preparing a standard
guideline across the globe
2- IIFS would need much stronger IT support than they have i.e.
a. More robust software and hardware support would be need at the time of implementation.
b. If a standard off the shelf software is prepared for these risk management tool that would help the industry in going forward in same and right direction
3- Most importantly training and development of
the staff related in the exercise would be required.
a. Training of the techniques/tools applied should be given to the risk related personnel while
b. Software related training should be given to the IT.
c. With this, a sample document should be prepared to teach the staff involved in the exercise.
No change. Suggested factors are already being discussed in the ED and the list of critical factors is presented in Section 2.
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BBP
16.
Specificities of IIFS such as direct equity investment risk and rate of return risk
The STWG should also highlight other risk specificities of IIFS such as direct equity investment risk and rate of return risk. Both were defined and described in detail in the IFSB-1. Both are important to the IDBG, especially the direct equity investment risk.
Wan
No change. These specificities are addressed already by the STWG in the ED. For instance, the rate of return risk is discussed in Principle 3.6 and equity investment risk is discussed in detail in Principle 3.13.
17.
Welcome the proposals, which are in line with our thinking on the developing capability and role of stress testing within the Enterprise Risk Management Framework (ERMF)
KFH welcomes the opportunity to comment on this Exposure Draft. We welcome the proposals, which are in line with our thinking on the developing capability and role of stress testing within the Enterprise Risk Management Framework (ERMF) that we are putting into place. We are currently in the process of substantially upgrading our stress test capability in preparation for the Internal Capital Adequacy Assessment for the year-end and have the active engagement of Senior Management and the Board in the implementation of the stress tests and the analysis of the results. We expect to use these results to calibrate our Risk Appetite and support the Corporate Strategy. KFHK
No change. Noted.
18.
Consistent benchmarking
Regulators should set internationally accepted criteria that are standardised for consistent benchmarking and avoidance of inappropriate selectivity by regulated institutions. BB
No change. The Council of the IFSB is comprised of various regulators and supervisory authorities and various representatives of these regulators and supervisory authorities were part of the STWG, to prepare
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internationally accepted best practices for consistent benchmarking across the IFSI. In addition, these Guiding Principles take into account the international developments related to stress testing such as those of BCBS and CEBS.
19.
Advanced approaches of capital adequacy
We recommend IFSB to encourage IIFS in migrating towards advanced approaches of capital adequacy which would ensure better infrastructure in place thereby improving the overall stress testing exercise at IIFS. AU
No change. Agreed on substance. The IFSB has required in its standards only standardised approaches, however, it has mentioned in its IFSB-2 (capital adequacy standard) that IIFS can use the advance approaches but subject to the approval of respective supervisory authorities. The IFSB intends to work on the advance approaches, and it hopes that then these approaches will be adopted by the IIFS thereby improving the overall stress testing exercise at IIFS
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Higher and more rigorous standards
Higher and more rigorous standards are needed for banks that post systemic risk, such as those with a market share of 10% or more. BB
No change. The IFSB is aware of the systemic risk and systemically important IIFS, which is addressed in the ED in the Paragraph 164 in Principle 4.3. The ED has already included the concept and application of proportionality with respect to stress testing practices and in this regard, respective supervisory authority is expected to provide clarity on the application of proportionality for IIFS within its jurisdictions and it is up to the supervisory authority to set any criteria or indicators to identify
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systemically important IIFS. See Principle 4.3.
21.
Design of the stress testing framework (STF)
The Design of the stress testing framework (STF) should avoid undue complexity in order to maximize transparency to and the understanding of those responsible for the appropriateness of the STF. BB
No change. The BOD (as the ultimate internal policy-maker) should have ultimate responsibility for the overall stress testing programme, whereas senior management should be accountable for the programme’s implementation, management and oversight. Further, it has been highlighted in the ED that the managements of IIFS should recognise that the application of stress testing to different IIFS will vary in scope and complexity depending on the size and nature of operations of each institution. It is also recommended that the design of the STF should take into account the views from the organisations.
22.
Various trigger-events and supervisory stress testing
The document should mention situations that would trigger stress tests and state how the supervisory authorities should ensue that the tests are carried out when these trigger-events happen. CBN
No change. Various trigger events and factors are already outlined in the Principle 4.3 and specifically the Paragraph 163 addresses this concern.
23.
Comparison of the Basel and IFSB papers
In our review of the stress testing exposure draft, we noted that the paper is over twice as long (53 pages) as the Basel Paper (20 pages), but is not twice as helpful. It is true that it has extra Principles such as Principle 3.8 with no direct equivalent in Basel, but Principle 3.8 extends over one and a half
No change. It’s clear that one shouldn’t expect a straightforward mapping of the BCBS principles. The market response (consisting of more than 60 Organisations) received from various stakeholders (including 18
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pages of description but ends up saying little that is specific for a bank to follow. 3.12 and 3.13 extend to over five pages but it is debatable how much value is added. But the critical aspect of the IFSB paper is the ‘cut & paste’ approach. Principle 3 of Basel is spread across 4 principles of the IFSB paper (3.2, 3.6, 3.7 and 3.17). Meanwhile IFSB Principle 3.11 covers 4 Basel Principles. This cutting and pasting, coupled with the descriptive length of the IFSB paper make comparison of the Basel and IFSB papers very difficult. CBB
central banks, more than 30 market players, and IMF, ADB, IDB, and others) indicates the usefulness of the ED. However, it is not clear from CBB response, in what ways; the guidance has not been helpful. Further, as set out in the objectives of the IFSB as mandated under its Articles of Agreement, the STWG should not “reinvent the wheel” but instead, wherever appropriate, reinforce the existing internationally recognised frameworks or standards for stress testing so that IIFS stand on a “level playing field” with their conventional counterparts, subject to due consideration being given to the specificities of Islamic finance. The Guiding Principles are thus intended to complement the existing stress testing framework so as to contribute to the soundness and stability of the IIFS particularly, and the IFSI as a whole (Paragraph 8). Therefore, consistent with objectives of the IFSB, the STWG has stressed number of times in the ED (see Paragraphs 1, 4, 8, and 9) that the objective of these Guiding Principles is not to reinvent the wheel rather complement the existing stress testing framework such as those of BCBS and CEBS. It should be understood that the ED does not only complement
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the BCBS’s Principles for Sound Stress Testing Practices and Supervision (20 pages) but also complement CEBS’s Guidelines on Stress Testing (47 pages guidelines which are more operational than BCBS), in addition to other relevant documents issued by BCBS. Hence, The IFSB intends that its Guiding Principles as set out in this document should incorporate the above while making appropriate adaptations to take account of the specificities of IIFS in terms of their risk exposures (Paragraph 4). The STWG has discussed the extensively and agreed with both the length as well as scope of ED. Both documents (i.e. from BCBS and CEBS) have been discussed by the STWG in detail and subsequently updates have been given to Technical Committee in its several meetings. It is important to note that the additional guidance which has been added through Survey that identified the gaps within IFSI and those gaps have been addressed in the Guiding Principles. On the similar note, the long length could be attributed to the fact that the ED attempts to use more operational approach given the IFSI industry feedback collected through Survey. In addition, the ED has also
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discussed some Principles which were not part of the BCBS and therefore the ED has provided Stress Testing Framework in a logical and a comprehensive manner taking into account the specificities of IIFS and international guidance on stress testing.
24.
Feedbacks from external credit rating agencies and/or central banks on this Exposure-Draft
Moreover, it is important that IFSB and the national supervisory authorities should obtain feedbacks from external credit rating agencies and/or central banks on this Exposure-Draft. Most of these bodies are familiar with Basel's stress testing guidelines (and/or European and American equivalent guidelines) and by which these bodies may not rate banks favorably if they are not complying with American/European/Basel guidelines. ITB
No change. This is part of the due process of the IFSB under Standard Operating Procedures (while developing any Standard) to get feedback from the various stakeholders including international bodies and various IFSB members. It is worth highlighting that the IFSB has received feedback on the ED from the various IFSB member central banks and international organizations such as International Monetary Fund (IMF). Accordingly the feedback has been reflected in the revised ED.
25.
Policies and procedures of stress testing
Requirement for policies and procedures of stress testing can never be treated as a compulsion for IIFS rather it should be treated as a regulatory requirement to start with. BBP
No Change. Policies and procedures are part of the effective stress testing programme and they should be properly documented. See Principle 3.4 for more detail. IIFS should treat them as integral part of their internal risk management rather than documenting because of regulatory compliance requirements.
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26. Many economic/political crises happened that did not severely impacted banks within Bahrain
The STWG may note that throughout the past two decades, many economic/political crises happened that did not severely impacted banks within Bahrain (in fact they went by un-noticed). To name some:
• ERM crisis in 1992-1993; • Mexican crisis in 1994-1995; • Asian crisis in 1997-1998; • Argentine crisis in 2001; and • Dubai (UAE), 2009-2010
You may agree that some worldwide shocks were advantageous to the region: for example the September 11 attack on New York caused capital flights from America and Europe in this region (i.e. the impact was positive rather than negative)! This probably supports our views that stress-testing mechanisms could reasonably predict financial crises. One could also refer to the recent European Crisis which implemented stress-testing since early 2000 but yet these stress-tests did not adequately predicted the recent crises. ITB
No change. Noted. It is understood that the severity of these crises vary from jurisdiction to another jurisdiction, so the case in Bahrain. It should be noted that the objective of the stress testing is not to accurately predict the next financial crisis rather assessing and capturing vulnerabilities under various stress testing scenarios. It should be also clear that stress testing itself cannot address all risk management weaknesses. For instance, one could clearly see from European Banking stress tests exercises that they were looking to pass the stress test rather to see what banks could get fail. We have see seen that some of the banks that passed the stress test, subsequently went through financial distress.
27.
Regulatory and tax impacts in stress testing
The guiding principle covering the topics such as IIFS should follow regulatory requirements for stress testing and /or guidance from supervisory authorities in their stress testing exercise. However, from regulatory perspective, the IIFS should also take into account regulatory and tax laws changes in the jurisdiction in which it operates which are specifically related to Islamic banking. The business of IIFS is largely based on transactions such as Ijārah, Murābahah, etc which involve transfers of real assets such as land, building, commodities and
Agreed. Now these regulatory and tax impacts have been reflected under the Principle 3.6 (i.e. key risk factors).
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any adverse regulatory or tax changes can directly affect the costs of doing business and hence the profitability of the IIFS. HKAB
28.
Various cross-border effects and their possible impacts on the stress-tests
We also recognise the importance of considering effects of cross-border economic crises on performance of banks. However, we believe that the Exposure-Draft should give due considerations to the various cross-border effects and their possible impacts on the stress-tests. Impacts of cross-border economic challenges come in two flavors:
• Direct Impact: Cross-border balance sheet linkage which might occur as a result of banks owning assets in ailing economies -> possible high impact; and
• Contagion impact: Effects of spillovers resulting from exogenous global shocks -> possible low impact.
As a result of the above we believe that the Exposure-Draft should not adopt a "one-size-fits-all" approach. Rather, the Exposure-Draft must direct regulatory authorities to define various stress-test parameters /templates (instead of one template) for various possibilities such as the 2 discussed above, ITB
Agreed. Though the cross-border impacts have been outlined in various places of the ED with respect to IIFS, however, the revised Paragraph under Principle 4.3 addresses this concern and include the suggested point with respect to supervisory authorities. The ED recognises this issue and therefore does not recommend “one-size-fits-all" approach (see first Paragraph of Principle 3.3) and hence it has used the principle of “proportionality” in various places to clarify this point. Secondly, as mentioned under the necessary conditions, supervisory authorities should also bear in mind the principle of “proportionality” with a view to establishing effective stress testing regimes in their jurisdictions (see Section 2.5).
29.
Exposure-Draft is placing on stress-testing as a prediction tool
We acknowledge the importance of utilizing "forward looking" reports in addition to "static" and "dynamic" reports in the decision making process. However, we are, somewhat, indifferent with the over-emphasis the Exposure-Draft is placing on
No change. The ED does not attempt to suggest stress testing as a prediction tool rather as risk management tool within risk management of an IIFS. In addition,
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stress-testing as a prediction tool. ITB
the ED is explaining how stress testing as a risk management tool, can be used by the IIFS to make forward looking assessment of risks and certainly forward looking assessment involves on more quantitative and expert judgment. It is also important to note that the existing models used by IIFS as a risk management tool such as VaR to assess the IIFS’ risks have failed to detect the vulnerabilities because VaR involves fitting the possible magnitudes of a risk exposure under a normal distribution curve, and as such is a type of risk measurement tool (with the weakness that it underestimates risks with ‘fat tailed’ distributions and does not measure them correctly for skewed distributions. Therefore, highlighting the need of having in place alternative tools such as stress testing to assess the risks (see second Paragraph of Principle 3.3).
30.
Standardized risk approach vs. sophisticated modelling approaches
This ED is suitable for IIFS which are trying to move from standardized risk approach to more sophisticated modelling approaches.
Wan
No change. It is expected that gradually most of the IIFS will also be moving to towards more advance approaches compared with what they are using now. The Guiding Principles have been designed keeping in view the impact study results (which provided insights into the approaches). The IFSB is also
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considering addressing advance approaches in near future.
31.
Immediately to overcome future data requirements
Chief Risk Officers in IIFS should start strategizing internal modeling techniques immediately to overcome future data requirements. The fact that current data is scarce should not hinder banks to start the process of collecting risk factors. Internal models are needed to compute expected loss for internal assets and periodic validation should be conducted independently to verify the model’s accuracy and robustness. Wan
No change. Noted. This is expected from the IIFS once the Guiding Principles are adopted.
32.
Problems with statistical models
We are confident that members of STWG are aware of the fact that over-reliance on statistical models led to economic meltdown of one of the biggest economies in the world (USA) where financial institutions over used V@R as a statistical-model for measuring risks. Some analysis that we have reviewed in this respect attribute the problems with statistical models to: (1) difficulty with predicting extreme rare risks especially those relating to contagion impacts, (2) historical data doesn't necessarily predict future outcomes, and (3) historical data may be biased by data aggregated during periods of economic crises or economic booms. ITB
No change. The STWG has discussed and addressed this issue in the ED. It should be clear that failure of VaR has indicated the use of stress testing to capture the extreme shocks which are normally not addressed within the historical data and therefore, historical data needs to be supplemented by the expert judgment or qualitative criteria. However, the issue of over-reliance has been discussed at the working group level and certainly the STWG has acknowledged it in the second Paragraph of Principle 3.3.
33.
Type-2 Model Risk
The former Head of the Federal Reserve, Alan Greenspan spoke of the “incipient science of stress testing”. We caution against excessive reliance on models that are not well understood or based on insufficient or inadequate data. In seeking to gain
No change. See response above.
23
acceptance for stress testing as a risk management tool we caution against what statisticians call Type-2 model risk, where the model indicates that all is well when it is not. For this reason we will continue to overlay management and Board judgment on the reliability of the results of the stress tests conducted at KFH. KFHK
34.
22 principles majority of them are covered in current CBK guidelines
Of the 22 principles majority of them are covered in current CBK guidelines are general principles. In addition KIB has based on its risk profile included specific scenarios in its internal methodology to ensure that the stress testing is comprehensive. Notwithstanding the principles in the Exposure Draft of IFSB which are either not explicit in the existing guidelines or could potentially be a cause of concern if the same were to be included in CBK guidelines has been discussed. KIB
No change. Noted.
35.
Guidelines are more detailed in nature
Most principles in the proposed IFSB draft are covered at a broad level in the existing CBK guidelines. The proposed IFSB guidelines are more detailed in nature. Thus implementation of the same may need more allocation of time and effort. KIB
No change. Noted.
36.
Vetted for Legal and Shari’ah compliance relevant
The exposure draft is definitely welcome but it needs to be ensured that the same is vetted for Legal and Shari’ah compliance relevant to the
No change. The IFSB has made explicit in the ED that the implementation of the Guiding
24
Kuwait before CBK incorporates the salient features into its regulatory guidelines.
KIB
Principles should be undertaken in compliance with Sharī̀ ah and within the legal framework of the jurisdictions in which IIFS operate and should be commensurate with the size, complexity and nature of each IIFS in line with the IFSB-1.
37.
6 principles prescribed are in line with the international standards (BIS)
As in other international documents the IFSB document also emphasis on the importance of supervisory review and assessment of stress testing programmes. The 6 principles prescribed are in line with the international standards (BIS) in this regard as is already being followed by CBK. KIB
No change. Noted
38.
Earlier instructions of IFSB
The document referrers at several places to adopting the earlier instructions of IFSB. These should be duly corrected to refer to as “…the instructions as issue by CBK in this regard for Islamic Banks in Kuwait”. KIB
No change. It is obvious that the IFSB can not make reference in the ED to any particular jurisdiction with respect to the implementation of its earlier standards. It is expected that IIFS should make reference to respective equivalent guidance issued by the respective supervisory authority on the specific standard.
39.
Guidelines may not be made mandatory but should be optional depending on applicability
All the prescribe guidelines may not be made mandatory but should be optional depending on applicability to be applied by each IIFS based on their proportionality (i.e. Depending on the size and nature of its activities as already stated in the Exposure Draft). KIB
No change. The Guiding Principles aim to reflect the best practices of stress testing and the IFSB does not intend to make these Principles mandatory to any IIFS rather same could be done by respective supervisory authority. Further the IFSB believes that implementation of these Principles will make IFSI more robust and sound so that IIFS stand
25
on a “level playing field” with their conventional counterparts, subject to due consideration being given to the specificities of Islamic finance. The concept of proportionality is discussed in the ED already.
40.
Output working models could be made jointly by all institutions together
In case of requirement of standardization of stress testing output working models could be made jointly by all institutions together with help from external party. KIB
No change. It is already discussed in Section 2.4.
41.
Cover wide ranging risk management perspectives
IFSB’s guiding principles on stress testing for Institutions offering Islamic Financial Services (IIFS) cover wide ranging risk management perspectives including:
• Forward looking risk quantification of potential risks
• Risk assessment from quantitative as well as qualitative aspects
• Risk assessment based on historical as well as rare and extreme possible scenarios
• Risk assessment based on contingent exposures
WB
No change. Noted
42.
Bank’s stress testing framework should cover….
Bank’s stress testing framework should cover at least following potential aspects:
• How bank’s credit and investment portfolios would behave in case of dramatic changes in economic variables such as profit rates, exchange rates or economic cycles of inflation, recession, tight credit, liquidity squeeze etc. This covers finding out
No change. These aspects are already addressed in the ED and reflected in various Guiding Principles.
26
sensitivity of bank’s assets to different market dynamics.
• Finding out all possible potential threats which could hinder bank’s normal operations in case of funding dry out, liquidity squeeze, lack of market trust, frozen interbank money market, short money supply, higher inflation / interest rates, deposit withdrawal etc.
• Assessing how a stressed scenario could impact bank’s profitability and bank’s capital.
WB
43.
IFSB Stress testing covers all above concerns with well given guidelines to assess potential risks.
We think IFSB’s paper on stress testing covers all above concerns with well given guidelines to assess potential risks. The IFSB paper has also tried covering issues which banks usually face in successful implementation of a wide ranging stress testing platform, issues such as:
• Majority of our stress tests are either sensitivity or scenario based. Banks rarely assess extreme loss, value or reverse testing.
• There is hardly any uniformity in the criteria, methodology or assessment of risk parameters for stress testing. Guidelines about models, reliability & comprehensiveness of data are some other constraints.
• Stress tests and their results are usually taken as granted as a matter of routine process. Results hardly lead to capital allocation. Guidelines lack for capital planning based on specific stress tests.
• Stress tests sometimes play a role of only up to risk awareness.
No change. These concerns and limitations of stress testing are already addressed in the ED and reflected in various Guiding Principles.
27
WB 44.
Compliance only through regulations
Compliance can only be effective if the same is regulated by Central Banks. DIB
No change. This is one of the necessary conditions of the effective stress testing regime. See 2.5 and Principle 4.1.
45.
Comprehensive of the explanation on what issues shall require national regulations
Due explanation was made in quite a detailed manner on the principles to be adhered to by lIFS's concerning the Stress Test in the document titled "Guiding Principles on Stress Testing for IIFS". In our: opinion, the concerned document is to be comprehensive of the explanation on what issues shall require national regulations and on what issues the international regulations shall have to cover all the countries so that a system in such a detailed fashion can be established at IIFS's. On the other hand, there exists DO clarity on such issues as from what institution or institutions the Interest-free Finance Institutions shall be able to acquire the Islamic Benchmark Rate and by what indices they shall take into account the changes in the prices of Houses/Flats or Mortgage if those principles mentioned here are established within IIFS's. CBRT
No change. The ED is already detailed and comprehensive, and detailed and specific framework and clarity on certain issues, keeping in mind the concept of proportionality, is expected to be provided to the IIFS by respective supervisory authority.
46.
Concerning the Benchmark Rate of the Institutions that offer Islamic Financing Service as
On the other hand, we believe that the guidelines on what sorts of stress scenarios could be established concerning the Benchmark Rate of the Institutions that offer Islamic Financing Service as regards to profitability, which issue is not mentioned in the Draft document, is to be included in the aforesaid Regulation as well.
No change. It is addressed in various places, for instance, see rate of return risk, which is addressed in Principle 3.6.
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CBRT 47.
More interested in the Governance related issues and not the detailed operational ones to get the big picture
As you know our focus, when it comes to Islamic Finance related research, is rather on the Corporate Governance part. Therefore I would rather like to abstain from this one as we can add much more value in our core area. Our complementary focus on the conventional investment industry, socially responsible investments and know how in Islamic Finance is indeed unique and helps us to better grasp the changes in the asset management and finance industry as a whole and globally. I must admit though that when it comes to Islamic Finance we are more interested in the Governance related issues and not the detailed operational ones to get the big picture. MURAT
No change. Noted.
48.
Stress Testing for relevant Islamic capital market intermediaries
Moving forward, the IFSB may wish to conduct a study and undertake assessments on the applicability of developing similar standards relating to Liquidity Risk Management and Stress Testing for relevant Islamic capital market intermediaries, e.g. Islamic stockbroking companies. SCM
No change. Agreed that consideration should also be given to addressing the application of stress testing to risk management in other IFSI segments such as Takāful and capital market firms, and the IFSB may consider this in future.
49.
Commend the efforts of the IFSB and the High level governance principles for stress testing
We did not find it necessary to specifically make comments on the documents as they contain high level governance principles for liquidity risk management and stress testing, with which we are in agreement and feel that they will create the market discipline needed for these functions to be effective. Thank you for inviting us to make comments. Arcapita is always there to support all the initiatives of the IFSB and look forward to
No change. Noted.
29
working with yourselves in the future also. ACB
50.
As usual, we commend the efforts of the IFSB and the Central Bank of Bahrain (as well as other central banks forming part of the IFSB) in developing rules for strengthening the financial sector and maintaining economy robust financial system resilient to economic shocks. ITB
No change. Noted.
51.
The IFSB has done an excellent work in developing a very comprehensive Guiding Principles on Stress Testing taking into considerations the additional areas that are only peculiar to Islamic [finance] such as Shari’ah non-compliance and the various underlying Islamic contracts used in the industry. OCBCA
No change. Noted.
52.
Needless to mention, the IFSB Guiding Principles are very comprehensive and useful and we feel that the same has to be first accepted and implemented by the central banks of the respective GCC countries. In Qatar, recently QCB has closed the Islamic windows of commercial banks and we look forward to their guidance on these important issues. MAR
No change. Noted.
53.
The guiding principles on Stress Testing are very comprehensive but their implementation challenges will need focus on capacity building at IIFS level in terms of IT Systems and human resource.
No change. Noted. IIFS will have to address these challenges before implementing these guidelines.
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ABP
54.
We have noticed that the document have sound and efficient principles and guidelines, and are primarily to serve Islamic Banks. Also, this document will enhance stability of the overall Islamic Banking Systems. ABL
No change. Noted.
55.
We believe that IFSB has prepared a very comprehensive document on Stress testing. Application of these guidelines would be a benchmark in safeguarding the interests of stakeholders of the bank. BBP
No change. Noted.
56.
The document on “Stress Testing” provides a comprehensive study for supervisory and internal regulatory controls. The Senior Management as well as the Board members needs to be aware of the impacts of the numbers generated through MIS and transform these into meaningful relative qualitative assessment. BAP
No change. Noted. These concerns are already well taken in the ED.
57.
I would congratulate the author(s) on producing such a comprehensive, not to say exhaustive, document. The level of detail will benefit all banks seeking to introduce robust stress testing procedures. Andrew
No change. Noted.
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58. We share IFSB’s view on the importance of a sound and robust stress testing framework for IIFS and appreciate in this regards. KHFB
No change. Noted.
59.
We strongly support the initiatives of the Islamic Financial Services Board in defining the guiding principles on Stress Testing… Stress testing has been identified as an important tool for pro-active management of would-be vulnerabilities. It encompasses several facets - ranging from pro-active oversight to maintaining transparency to stakeholders - which are all essential in addressing institution- specific and system-wide weaknesses. We are particularly supportive of the fact that the EDs contain tenets that would allow the management of both in Institutions offering Islamic Finance Services (IIFS) and in conventional banks. Consistently handling the challenges provided by these two will lead to clear synergies. We welcome the 28 principles outlined by the Islamic Financial Services. Board (IFSB) on stress testing for Institutions offering Islamic Finance Services (IIFS). Of the 28 principles, it is noteworthy that 6 of these are addressed to the regulators, suggesting that the overall guidance on the practice of stress testing is shared between the IIFS and its regulatory authority. The principles are particularly welcomed since it complements the same practice in conventional banks. Under the overarching objective of financial stability, this complementation between Islamic and conventional banking is an area that should be continuously nurtured. Ultimately, it is governance
No change. Noted.
32
and the management of risks that will define the "state" of a bank, whether operating under Islamic or conventional guidelines. However, stress testing is perhaps the most viable ex ante risk monitoring tool that is available to date and in this sense, its value cannot be understated. BSNP
SECTION 1: INTRODUCTION AND BACKGROUND 60.
Paragraph 1 - …….These Guiding Principles are intended to complement existing and future IFSB standards and guidelines in the banking segment of the IFSI……..
No need for mentioning to complement "future" standards and principles. Only can make reference to the existing standards and principles. CBOS
No change. The IFSB does intend to issue and/or revise its some of standards which will benefit from this guidance. Moving forward, for instance, supervisory review process (IFSB-5), which will include some aspects of stress testing under Pillar II, similarly the guidance on ICAAP will benefit from these Guiding Principles.
61.
Paragraph 3 – “……..It was also observed that there was insufficient integration into institutions’ risk management frameworks, that scenarios were not sufficiently severe, that the dangers considered in "extreme" scenarios were not extreme enough (e.g. Irish banks that had failed disastrously passed the European Union (EU) stress testing exercise), and there was lack of consideration of confluences of events, risk concentrations and second-round
Referring to Irish banks passing an EU stress test. The text should specify that this test was published in July 2011, since the European Banking Authority conducted others tests later in the year. Andrew
Agreed. This has been updated.
33
effects.
62.
Paragraph 5 - …….With regard to the specificities of IIFS, the question remains of how well IIFS will be able to absorb stresses and shocks that are more specific to the Islamic financial market, with regard to credit, market, operational, and (perhaps particularly) liquidity risks. This implies an approach to stress testing (including various specific scenarios) that differs in some respects from that applicable to conventional institutions, which this document aims to set out and to explain.
Credit, market, operational and liquidity risks are not specific risks that are related to the IIFS, as conventional banks have exposure to these kinds of risks as well. Instead, it would be appropriate to make reference to risks that specific to IIFS like displaced commercial risk and fiduciary risk. CBOS
Agreed. The paragraph is updated with rate of return risk and displaced commercial risk. In addition, a cross reference to Paragraph 7 also has been made.
63.
Paragraph 6 -….however, IFSB-1 did not give specific consideration to: (i) how to apply and conduct stress testing; and (ii) what should be the stress scenarios, the calibration of shocks to be applied, etc. …….
Clearly, IIFS would be keen to know how to apply the Guiding Principles contained in the document including illustrations of how to perform Stress Testing. Paragraph 6 of Section 1 states: “…however, IFSB-1 did not give specific consideration to: (i) how to apply and conduct stress testing; and (ii) what should be the stress scenarios, the calibration of shocks to be applied, etc. … The guiding principles in this document aim to complement …IFSB-1 and IFSB-5 in the above respects.” It was not apparent from our review of the ED where the above two issues are addressed and the ED may be perceived as too theoretical and lacking guidance on how to implement Stress Testing in practice. IDB
Agreed. The paragraph is revised and updated in order to clarify the limitations mentioned with respect to IFSB-1. See revised Paragraph 6, which includes following wordings…. however, IFSB-1 did not give specific consideration to “a comprehensive stress testing framework as a key risk management tool within IIFS”. In regard to how to apply the Guiding Principles contained in the ED, it is not the key objective of this ED, broadly speaking respective supervisory authorities are expected to provide the implementation guidance taking into account the local
34
context and specificities. Moving forward, however, this is one of the promising issues which have been raised by the various respondents during the public consultation and the IFSB may consider addressing in detail through “implementation guidance”. See responses in (9) and (10) above.
64.
Paragraph 7 - There are particular considerations to be borne in mind in the case of IIFS. ……special attention to the position of the investment account holders (IAHs) and its implications for risk management. .…the IIFS are also exposed to other unique risks, such as rate of return risk and displaced commercial risk (DCR), and specific aspects of operational and reputational risk such as Sharī̀ ah non-compliance risk …
The para makes reference to risks that IIFS entails beside the investment account holders. It would be appropriate if the Para. starts with explaining or highlighting the specificities of IIFS so as to enable the ordinary reader to capture and follow up why IIFS warrant special treatment when undertaking stress testing. CBOS
Agreed. Consistent with another suggestion by CBOS on the shifting of Para.20 into introduction section, this Para.20 (which is on specificities) has been merged into Paragraph 7. See revised and updated Paragraph 7.
65.
We welcome the efforts of the IFSB to create a level playing field for Islamic business. SAMA
No change. Noted
66.
Paragraph 8 of 1.1 - main premises and objectives)
It might be useful for the document to be a little more explicit about the objectives of stress testing. For supervisors, the objective is to maintain financial stability and this may, or may not, include a desire to avoid the occurrence of individual bank failures. Supervisors would typically test whether
No change. The ED is very specific to the objectives which have been listed in the Section 1.1 and they are divided into two perspectives. One on IIFS stress testing and second on supervisory role of stress testing. The ED focuses more on providing
35
banks will be able to continue to comply with bank regulations (e.g. capital minima, liquidity buffers) under a variety of stress scenarios. Their assumption would be that widespread inability to meet regulatory requirements would likely presage financial instability. Andrew
framework on stress testing and providing minimum expectations such as outlined in Paragraph 9 (b). With respect to supervisory perspective, issue of financial stability is addressed in Paragraph 9 (c). At macro level stress testing, agree with the observation that supervisors would typically test whether banks will be able to continue to comply with bank regulations (e.g. capital minima, liquidity buffers) under a variety of stress scenarios. These considerations are addressed in detail in the ED Principles 3.10, 3.14, and 4.1.
67.
Paragraph 8 - As set out in the objectives of the IFSB as mandated under its Articles of Agreement, the STWG should not “reinvent the wheel” but instead, wherever appropriate, reinforce the existing internationally recognised frameworks or standards for stress testing so that IIFS stand on a “level playing field” with their conventional counterparts, subject to due consideration being given to the specificities of Islamic finance.
We would suggest to rephrase this sentence to be the working group has been mandated to customized and/or complement the existing international guidelines to cater for the specificities of the IIFS. CBOS
No change. This is consistent with the objectives of the IFSB as mandated under its Articles of Agreement.
68.
Paragraph 9 (b) (i) - …benchmark rates…)
It would useful to clarify what hurdle rates would be used for the stress testing, Basle II or Basle III? (Assuming these are applicable in Islamic banking). IMF
No change. The ED complements the Basel II and what has been included in the ED is reference to certain benchmark rates/hurdle rates (as guidance) since it is understandable
36
that the applicability of these rates will vary from IIFS to another IIFS. The footnote 5 of the ED provided some illustration of what benchmark rates/hurdle rates could be used for the stress testing. For instance, benchmark rates include market-based reference interest rates such as LIBOR (London Interbank Offer Rate), EIBOR (Emirates Interbank Offer Rate), etc.)
69.
In addition to stress-testing the benchmark rates, foreign exchange rates, credit quality, etc., IIFS and supervisory authorities should also stress test the new Islamic Interbank Rates (IIBR), wherever applied by the IIFS in order to identify how different portfolios of the IIFS respond to changes in key economic variables. This is important because if the IIBR could really be the alternative to LIBOR, then its rate should be tried and stress-tested to ensure its workability, acceptability and reliability.
Wan
No change. As for as this ED is concerned, it makes reference to general reference rates which could serve as benchmark rates as mentioned in the previous response. Nevertheless, it is up to respective supervisory authorities to require IIFS to take into account specific benchmarks such as suggested. It is expected that these benchmark when developed in isolation, that is, without making reference to prevailing market rates, then the workability, acceptability and reliability would be a key concern for both IIFS and their supervisory authorities and therefore they should be tested at respective supervisory level before requiring to IIFS.
70.
Paragraph 9 (b) (v) - Analyze the IIFS' ability to meet its capital requirements.
Suggest adding the word "economic" to capital to be "economic capital" as stress testing is related to the economic capital. CBOS
No change. Stress testing is not only related to “economic capital” rather also “regulatory capital” and both of these requirements are addressed in the Guiding Principles, particularly in
37
Principle 3.10. See Principle 3.10.
71.
Paragraph 9 (c) - For supervisory authorities, stress testing can be used (i) as a surveillance tool for periodically testing the safety and soundness of the financial system, and (ii) ……to identify “weaknesses” in the financial system and structural (systemic) vulnerabilities arising from the specific risk profiles of IIFS individually and collectively.
The draft could add that stress testing outcomes could also play a role in designing macro-prudential policies. IMF
Agreed. The Paragraph 9 (c) is updated to reflect the suggestion by the IMF.
72.
Paragraph 10 - However, in order to be effective in promoting risk management and for IIFS to develop a robust stress testing framework , stress testing by IIFS would be need to be complemented by a set of infrastructure components that serve as necessary conditions …"
Infrastructure components are considered as prerequisites to conduct stress testing and could not complement to stress testing. We would suggest to change/ replace the word "complement" by the word "require" CBOS
No change. The word “complemented” has been used in the right context as the list of these necessary conditions is not the exhaustive rather some of primary considerations which can enhance the stress testing framework. In addition, this also take into account the fact that stress testing is still being performed even without these conditions, however, having in place these conditions will certainly improve the quality of stress testing framework. Further, one should also keep in mind that stress testing should also be complemented by the observance of international standards for stress testing.
73.
Paragraph 11 (scope of application)…..….The Guiding
We believe it is correct for the Supervisory Authority to decide how to extend the application of this guidance to Islamic windows.
No change. Noted
38
SAMA
74.
Principles are primarily intended to serve the full-fledged banking IIFS with due consideration to proportionality taking account of their size, sophistication and complexity....Supervisory authorities may, at their discretion, extend the application of these Guiding Principles to Islamic “window” operations that are self-contained or other institutions offering Islamic financial services that fall within their jurisdictions).
According to para. 11 of ED13, the Guiding Principles in general do not apply to Islamic windows operations. However, supervisory authorities may, at their discretion, extend the application of these Guiding Principles to Islamic windows operations that are self-contained. It would be helpful if the IFSB could elaborate on the rationale for not requiring the Guiding Principles to apply Islamic windows operations and provide guidance on factors that supervisory authorities should consider when deciding whether an Islamic windows operation should be subject to the Guiding Principles. HKMA
No change. This is not the scope of this ED to elaborate on the rationale for not requiring the Guiding Principles to apply Islamic windows operations. In this respect, supervisory authorities are referred to IFSB-5 (supervisory review process (SRP)) in the footnote which is already added in the Para.11. This is Pillar II (supervisory review process) issue which is to be addressed under revised SRP (IFSB-5) standard (the IFSB has established working group for revising IFSB-5). In this ED, it is left to the respective supervisory authorities to decide how to extend the application of this guidance to Islamic windows, at their discretion, however, the IFSB notes the suggestion of HKMA and the revised SRP can provide guidance on factors that supervisory authorities should consider when deciding whether an Islamic windows operation should be subject to the Guiding Principles.
75.
Para. 12. - The Guiding Principles will be applicable to any IIFS that falls within the scope as stated above, on a fully consolidated basis at the holding company level within a group or sub-group of IIFS, or as appropriate, on an individual basis subject to approval of the
Paragraph No.12 provides that the Guiding Principles will be applicable to the IIFS on a fully consolidated basis at the holding company level. Here it would be required to be clarified that the stress testing would be required to be done individually at subsidiary level and thereafter individually at the holding company level. The results of these individual stress testing would be
Agreed with suggestion. A new footnote in Paragraph 12 has been added to clarify this point.
39
then required to be consolidated for analytical purposes. It is important that stress testing is conducted on an individual basis for each entity as the individual entities would be exposed to different types of internal and external risks which would be required to be appropriately accounted for. The element of correlation of different risks for an individual entity and amongst other entities within the group should also be accounted for when consolidating the results of the stress testing. ITB
76.
supervisory authorities. The Guiding Principles are not intended to be applied at the consolidated level to a group or sub-group that consists of entities other than (banking) IIFS as defined in paragraph 11 above.
… as defined in the standard …"What is intended in the guiding principles not "standard". CBOS
No change. There is no such wording of “as defined in the standard” in the Paragraph 12 of Guiding Principles.
77.
Paragraph 13 - ….. The Guiding Principles describe both qualitative and quantitative aspects of stress testing while keeping in view the principle of proportionality; that small and simple IIFS may focus on the qualitative aspects while larger, more complicated IIFS will require more sophisticated quantitative stress testing techniques. The principle of proportionality is applicable to all aspects of these Guiding Principles, including the governance process, risk identification and scenarios development, methodology, disclosures, …….of the stress tests.
Whilst it is reassuring that IFSB makes some concessions to “small and simple” IIFS in complying with the comprehensive range of requirements detailed in this Guiding Principles paper, it is still a bit sketchy on determination on what constitutes a small bank. More clarity on this would be good, but in the interim we take it respective IIFS will make this call themselves. ARBM
No change. It is outside the scope of the ED to suggest any methodology or criteria which would determine what constitutes a small bank and sophisticated bank rather it is expected that respective supervisory authority would be able to determine such distinction. This is reflected in the Section 2.5, which requires respective supervisory authority to provide clarity on the principle of proportionality.
40
78.
Paragraph 15 – Stock taking initiatives -Survey
We would also appreciate if the IFSB can share with the IIFS the range of stress testing practices and methodologies across the industry. KFHB
No change. Due to confidentiality with other participating IIFS in the Survey exercise in terms of sharing their experiences with respect to stress testing, it is not the policy at the IFSB to share the range of practices and methodologies with other IIFS, collected through the Survey. However, the ED does reflect the best practices that were identified during the Survey at certain places, where appropriate, to guide IIFS and also the executive summary of the findings is presented in the ED and several references to different practices are made in the ED at various places.
79.
Paragraph 16 - The implementation of the Guiding Principles should be undertaken in compliance with Sharī̀ ah and within the legal framework of the jurisdictions in which IIFS operate and should be commensurate with the size, complexity and nature of each IIFS in line with the IFSB-1. The IFSB will expect its members to apply the present Guiding Principles by January 2013, meaning that by this date the guidelines should be transposed into national supervisory guidelines and be reflected in the national supervisory manuals/handbooks, where applicable, and implemented in
No main comments regarding the ED, however, one concern relating to the implementation date January 2013, which we found too early considering other new regulatory requirements. KHCB
No change. The IFSB expects its members to apply the Guiding Principles by January 2013, meaning that by this date the guidelines should be transposed into national supervisory guidelines and be reflected in the national supervisory manuals/handbooks, where applicable, and implemented in supervisory practices, however, respective supervisory authority may extend its implementation deadline depending on (i) the readiness of the IIFS in its jurisdiction (ii) supervisory guidance (iii) and supervisory expectations on the implementation (different phases).
41
80.
We would like to suggest that the proposed implementation timeline of January 2013 should be reviewed and the implementation should be in a phased manner. KFHB
No change. See response in (79) above.
81.
Looking at the many and granular stipulations of this paper, and the infrastructure and resources required to implement same, it is foreseen that some IIFS may struggle to meet the January 2013. It is hoped that some leeway may be given on this. ARBM
No change. This is expected and this will depend on the relevant supervisory authority discretion. See also response in (79) above.
82.
supervisory practices.
The IFSB expects supervisors to include these guidelines in their respective regulation by January 2013. There should be at least 1 semi-annual and full year trial reporting before formal reporting is initiated. KIB
No change. This is up to the relevant supervisory authority discretion. See also response in (79) above.
83.
These principles which are required to be implemented by January 2013 would help banks to assess potential risks by looking beyond the limited period historical data. The recent financial crisis has shown that banks which rely on only historical events, limited scenarios or VaR models could face quick capital evaporating shocks. WB
No change. This has been highlighted in the Paragraph 37 of Principle 3.3.
84.
Paragraph 16 - The implementation of the Guiding Principles should be undertaken in compliance with Sharī̀ ah and within the legal framework of the jurisdictions in which IIFS operate and should be commensurate with the size, complexity and nature of each IIFS in line with the IFSB-1. The IFSB will expect its members to apply the present Guiding Principles by January 2013, meaning that by this
A requirement of approval of the Sharia Board should be incorporated in respect of compliance of
No change. The IFSB has made clear
42
the Guiding Principles implementation. DIB
in the ED that the implementation of the Guiding Principles should be undertaken in compliance with Sharī̀ ah and within the legal framework of the jurisdictions in which IIFS operate and should be commensurate with the size, complexity and nature of each IIFS in line with the IFSB-1.
85.
Implementation timeline for January 2013 will be challenging DIB
No change. See also response in (79) above.
86.
date the guidelines should be transposed into national supervisory guidelines and be reflected in the national supervisory manuals/handbooks, where applicable, and implemented in supervisory practices.
We understand that the implementation date of January 2013 stipulated in the Exposure-Draft is for national regulatory authorities (i.e. members of the IFSB) by which date these regulatory authorities should issue their own guidelines for banks to comply with. Once that is done, we would expect the national supervisory authorities to give the banks sufficient time to comply with these requirements (i.e. by January 2014). ITB
No change. Noted. See response in (79) and (81) above.
SECTION 2: NECESSARY CONDITIONS FOR AN EFFECTIVE STRESS TESTING REGIME 87.
Section 2 – Necessary conditions for an effective stress testing regime
We would like to emphasize that the prerequisites mentioned in the Section 2: Necessary conditions for an effective stress testing regime should be addressed in order to implement the guidelines. KFHB
No change. Noted. This would be expected as without addressing these conditions, it will be relatively difficult for IIFS to implement the Guiding Principles when required by the respective supervisory authorities.
43
And also when supervisory authorities will assess the IIFS’s compliance to these Principles, then it would be implicitly taken into account.
88.
When referring to the costs for banks of developing and implementing such a stress test exercise, one could also elaborate whether there will any cost for the supervisory agency in checking the quality of the models and outcomes by the banks, and supposedly carry out the own top-down calculations. IMF
Agreed. The Para.18 is updated to reflect the suggestion of the IMF.
89.
Para. 18 - ….IIFS should also be aware of the costs of developing and implementing such a stress testing programme. It is recognised that these costs may seem high for some IIFS, particularly small or medium-sized ones. However, the costs must be weighed against the potential loss mitigation, the value of the information and risk control gained, and the capital management that will result from an effective, well-designed stress testing programme.
Again the question arises on what constitutes a “small or medium” IIFS, which we take it the respective IIFS, will make the determination themselves. More details on this would be good, so that there is no debate when IIFS makes the strategic decision on the costs it is willing to defray to set up an effective stress testing programme. ARBM
No change. See response in (77) above.
90.
Paragraph 19 – “……the IFSB recognises that the specific stress testing practices adopted by each IIFS as part of its risk management framework will vary in scope and content depending on the size and nature of its activities, which will determine the likely impact of any potential risk scenarios..….in addition, regulatory requirements for stress testing and/or guidance
This is in reference to 2.1 Stress testing as a Set of Tools within a Risk Management Framework, page 9 of ED-13. Please explain and consider re-phrase the following sentence; “In addition, regulatory requirements for stress testing and/or guidance from supervisory authorities should be seen as an additional level of control to ensure compliance, and not as the reason for undertaking a stress testing exercise.”
Agreed. The sentence has been rephrased and following is added before the sentence, “Once the integration of stress testing has been effected by IIFS into their formal risk management framework, the regulatory requirements for stress testing and/or guidance from supervisory authorities should be seen as an additional level of control”.
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We do not think stress testing as merely a compliance tool. Stress testing should form an integral part of the overall governance of the IIFS as rightly stated in the Principle 3.1. The italic sentence above contradicts the Principle 3.1. Wan
91.
from supervisory authorities should be seen as an additional level of control to ensure compliance, and not as the reason for undertaking a stress testing exercise.
While it is important to establish standardized guidance for stress testing programs it should be ensured that none of the guiding principles especially the “”specific elements” (principle 3.9 to 3.16) of IIFS stress testing draft should be made as mandatory. This is as per the principle within the draft which says that the stress testing practices adopted should commensurate with the nature of activities of the institutions. KIB
No change. The concept of proportionality is already discussed in the ED. The Guiding Principles aim to reflect the best practices of stress testing and the IFSB does not intend to make these Principles mandatory to any IIFS rather same could be done by respective supervisory authority. Further the IFSB believes that implementation of these Principles will provide “level playing field” to IIFS with their conventional counterparts, subject to due consideration being given to the specificities of Islamic finance.
92.
Para. 20 - It is important for IIFS to understand and take account of the implications for risk management arising from the differences between their operations and balance sheet structures and those of their conventional counterparts (see Section 3.3 for more details). ……..
The Paragraph is about the specific features of IIFS, so we would suggest putting it in the introductory section. CBOS
Agreed. It is updated. See revised Paragraph 7.
93.
Paragraph 22 - Lack of an adequate database has been a major challenge for IIFS (as for
To include that in the absence of data or significant data constraint, IIFS should explore relevant proxies. These proxies may be derived from other
Agreed. This is reflected in the Section 2.2 now.
45
assets that possess similar risk characteristics or industry benchmarking. If proxies are used, IIFS should document the source and any known limitations comprehensively. BNM
94.
many conventional banks) in conducting stress testing exercises. Some IIFS may indicate that they have insufficient data to conduct credible stress tests. …IIFS management need to recognise that with inadequate data they may be more limited in their ability to recognise risk exposures and how to manage them. The management of an IIFS should establish a strategy and a plan, with the involvement and approval of the BOD, for acquiring the data needed for a credible stress testing programme based on the composition and characteristics of the IIFS’s asset portfolio and sources of funding…… The IT and management information system (MIS) resources should be commensurate with the complexity of the techniques and the coverage of stress tests carried out.
Several principles prescribed in the draft exposure would require MIS and data with high quality. Emphasis and stress should be given on this area. Accordingly sufficient time should be given for implementation where detailed data is requirement / multiple of data collection is required. KIB
No change. This is up to the discretion of the relevant supervisory authority.
95.
Paragraph 23 - The managements of IIFS should recognise that the application of stress testing to different IIFS will vary in scope and complexity depending on the size and nature of operations of each institution. Some IIFS are relatively small and have fairly simple asset portfolios…..
This paragraph describes that the application of stress testing will vary in scope and complexity depending on size and nature of operations. However, there is need for a minimum guidance by supervisory on the level of complexity required. This is to ensure the relevance of application and stress test will be conducted based on appropriate benchmark commensurate with the risk profile of the IIFS. BRM
No change. Clear and comprehensive specific guidance to IIFS on supervisory expectations for stress testing is considered one of the important necessary conditions (see Section 2.5) and it is expected from supervisory authorities as part of the review and assessment of IIFS’ stress testing programme. Also supervisory assessment of IIFS’ stress testing will depend on the adequate guidance
46
provided to IIFS. However, keeping in view the significance of the issue raised, this point has been reiterated in the Principle 4.1.
96.
Paragraph 24 - …….Some may feel they do not have the modelling and/or analytical expertise to implement a stress testing programme. This represents a management constraint that must be addressed within a realistic time frame. The models for stress testing, whether obtained from elsewhere (e.g. from software vendors) or developed in-house (possibly with the help of consultants) should be appropriate given the size and complexity of the IIFS, and enable it to address its particular risks……..
Taking the qualification of “appropriate given the size and complexity of the IIFS” we regard this as allowing smaller IIFS to build its expertise on stress test modelling organically due to the usual constraints smaller banks face. This does not mean any abrogation of end quality of their stress test methods, only that the time undertaken to develop the right model and reach the desired end state may be longer than what bigger IIFSs with more resources may enjoy due to their ability to pay for outside expert help, for example. ARBM
No change. Agreed with the example. This is expected from the IIFS and this is reflected already in the Section 2.4.
SECTION 3: GUIDING PRINCIPLES ON STRESS TESTING FOR IIFS
Principle 3.1: Stress testing should form an integral part of the overall governance of the IIFS. The ultimate responsibility for the overall stress testing programme of the IIFS should be with the Board of Directors (BOD). BOD and senior management involvement in the stress testing programme is essential for its effective operation. Stress testing programmes should be acted upon and should influence decision-making at all appropriate levels of management in an IIFS.
97.
Principle 3.1
Agreed. Board and senior management involvement in the stress testing programme will make it effective. AIB
No change. Noted.
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98.
Principle 3.1
This has been complied in Maybank. Stress testing scenarios & its outcomes are deliberated at our Board RMC, whilst the Group Stress Testing Framework is approved by the Board. MBM
No change. Noted.
99.
Principle 3.1
We agree this principle. We are undertaking a comprehensive stress test as part of our ICAAP using new methodology. We have the active engagement of Senior Management and the Board. As we have developed a new methodology we are focusing in the first instance on the analysis and results. The steps to formalize the governance and management of the stress test process will be implemented following submission of the ICAAP to the Central Bank. KFHK
No change. Noted.
100.
Principle 3.1
For stress testing to become an integral part of overall risk governance and decision making, banks might need to be given regulations with defined criteria, scenarios and parameters. Leaving banks to define their own forward looking criteria might not be sometimes enough for bank’s management to align policies with stress test results. WB
No change. This is expected from the relevant supervisory authorities. The ED has clearly stated that clear and comprehensive specific guidance to IIFS on supervisory expectations for stress testing should be provided.
101.
Principle 3.1
We are of the opinion that this is a little too ambitious considering the various stages of development of Islamic Finance in our Member Countries (MC), some of which are at very early stage of development.
No change. Stress testing exercise without governance and accountability is not effective at all. This is one of the significant requirements for stress testing consistent with BCBS and CEBS. Therefore, member countries
48
Wan
are expected to take into account this requirement as important part of stress testing framework.
102.
Paragraph 29 - …BOD should be able to identify and clearly articulate the IIFS’s risk appetite and understand the impacts and implications. …..
The guiding principle stated that the “BOD should be able to identify and clearly articulate the IIFS’s risk appetite and understand the impacts and implications of stress events on the risk profile of the IIFS”. Please describe minimum requirements related to risk appetite and implication to stress test. BMMB
No change. Actually, risk appetite represents how much risk or losses an IIFS is willing and able to stand in order to reach the target results to assume consistently with its strategy. The ED does not aim at listing what minimum requirements related to risk appetite should be as it is outside the scope of the ED. It is understandable that risk appetite of an IIFS will significantly vary from one IIFS to another IIFS due to the sophistication of an IIFS (see Section 2.2). The primary scope of the stress testing has to reflect risk tolerance limits and risk appetite as set by the IIFS’s BOD, though stress testing exercise can provide and identify vulnerabilities which might exceed the risk appetite as set by the IIFS’s BOD. Therefore, it needs to be structured in a dedicated framework to be implemented in an IIFS. It is understandable that the overall target of risk appetite is to ensure the long-term viability of business activities by avoiding excessive risk taking, which could put in peril the IIFS’s survival. When the risks exceed the set thresholds, remedial actions are to be taken. Hence, the full implementation
49
of the risk appetite needs a target and a limit to be set by the BOD. That means the risk appetite metrics, their limits and targets must be approved by the BOD as an integral part of stress testing framework. In case of a limit breach as a result of stress testing, it is necessary senior management informs the BOD and presents the remedial actions, asking for approval if needed, e.g., in case of asset disposal or right issuing.
103.
The 'Governance Committee' role, at Board level, is specifically mandated to protect the interests of the Investment Account Holders (IAHs) recommend under IFSB-3 (Guiding Principles on Corporate Governance). This Committee is highly recommended by IFSB, although not mandatory, provided:
a) The suggested role is performed by some other Board Committee
b) It is chaired by an independent Board member, and
c) Is explicitly mandated to monitor the governance policy framework of the IIFS and safeguard the interests of IAHs.
SAMA
No change.The ED does not deal with issues related to 'Governance Committee’, which are addressed in a separate IFSB standard under IFSB-3, rather the ED makes cross-reference to it with reference to IAH related stress testing. The inclusion and involvement of 'Governance Committee’ has been explained in the Paragraph 30 and two further footnotes 15 and 16 also clarify this point.
104.
Paragraph 30 - The Governance Committee (or an equivalent committee) should be actively involved in the development of the scenarios with respect to investment account holders, particularly in the context of unrestricted IAHs ………..as presented in Principle 3.9 (i.e. on IAHs-related stress testing). ….
We agree that the ultimate responsibility for the overall stress testing program rests with the Board of Directors (BOD). However, as noted above, there may be some conflicts of interest if the actual design of the stress scenarios and other operational details are left entirely to senior management.
No change. It should be noted that involvement of the Governance Committee is restricted only to the the development of the scenarios with respect to investment account holders, particularly in the context of unrestricted IAHs (as their funds are
50
Further elaboration of Principle 3.1 in page 14 provides that the Governance Committee (GC) should be actively involved in the development of stress scenarios. Judgment may have to be exercised, however, if this activity is "too operational" to be lodged under the responsibilities of the GC. As an alternative, well-considered stress scenarios may be presented to the GC or the BOD for their appreciation. Since governance starts with the BOD, the presumption is that the members of the Board can appreciate the consequences and implications of the stress testing program. On the other hand, one way by which the BOD and senior management can ensure that the practice of stress testing receives the right amount of attention within the governance framework of the IIFS is by committing adequate resources to the program. This includes hiring personnel with appropriate backgrounds, recognizing their expertise, and compensating them accordingly. The work of such personnel must also be subject to BOD and senior management oversight. BSNP
commingled with the IIFSs’ own funds) as presented in Principle 3.9. Therefore, the ED does not recommend the involvement beyond that role. In addition, with respect to the suggestion (i.e. well-considered stress scenarios may be presented to the Governance committee), this is already explicit in the term “involvement” which implies this suggestion, but this is restricted to IAHs only.
The IFSB agree with BSNP that BOD and senior management should ensure that the practice of stress testing receives the right amount of attention within the governance framework of the IIFS by committing adequate resources to the program. This is also addressed in the Principle 3.2.
105.
Paragraph 31 - A stress testing programme as a whole should be acted upon and feed into the decision-making process at the appropriate management level, including strategic business decisions of the BOD or senior management. ….stress tests should be used as an input for
This paragraph describes that the stress test should be used to support a range of decisions such as long-term business plan, capital and liquidity planning process. These activities usually details out action plan from either top down or bottom up approach to get into definite target. In contrast, stress testing results always entails closer to 0 (zero) percent of the probability of occurrence, which reflect extreme but plausible case. The
No change. The stress testing results do not entail closer to zero (0) percent of the probability of occurrence, if that is the case, then the whole stress testing programme is questionable and will not serve the intended purpose because stress testing programme as a whole should be acted upon and feed into the decision-
51
setting the risk appetite of the IIFS or setting exposure limits…….should also be used to support the evaluation of strategic choices when undertaking and discussing longer-term business planning…should feed into the capital and liquidity planning process. The detail of the action plans and a range of decisions are outlined in Principle 3.21.
influence of the stress test may only be limited to preparation of contingent action plan and to certain extent defining the portfolio mix. BRM
making process at the various levels. The influence of the stress test should not only be limited to preparation of contingent action plan and to certain extent defining the portfolio mix. See Principle 3.21.
Principle 3.2: A stress testing programme should be an integral part of an IIFS’s risk management framework and be supported by a suitably robust infrastructure, which is sufficiently flexible to accommodate different and possibly changing stress tests at an appropriate level of granularity.
106.
Principle 3.2
Agreed, stress testing programme & infrastructure should be sufficiently robust and flexible. AIB
No change. Noted.
107.
Principle 3.2
The Bank is agreeable to the Principle above, and stress test automation is planned for implementation in the very near future. MBM
No change. Noted.
108.
Principle 3.2
The system is expected to be of a flexible and changeable structure in face of any potential amendment; e.g. subjecting the credit portfolio to different analyses according to segments or separating them on bases of risk-types/ business-lines. CBRT
No change. This is expected from the IIFS to take into account.
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109. Principle 3.2 We agree this principle. The structure and governance implemented in KFH will reflect this principle. KFHK
No change. Noted.
110.
Principle 3.2
For stress testing to get the importance as one of the major risk management criteria and decision making, banks would need allocating resources for a right infrastructure but for which banks might need to be convinced that stress tests and their results are actually useful in implementing bank’s risk management strategy. WB
No change. Noted.
111.
Principle 3.2
Whilst we agree that stress testing programme should be an integral part of an IIFS’s risk management framework, we think that its robust infrastructure may be asking too much of our MC’s IIFSs.
The lack of internal data to derive adequate internal computation of Expected Loss (EL) is very true for most IIFS as they have just started offering Islamic Banking or have not had losses so far. The key is to start collecting data right away and enhance the granularity of the distribution curve as time evolves and in the interim add external proxy data to overcome data gaps. A periodic validation process is necessary to enhance the model as time evolves.
Wan
No change. Data constraint is explained in the Section 2.2.
112.
Principle 3.2
The summary does not emphasize the importance
No change. The existing wording of
53
of stress testing program to be integrated with the business and strategic planning process. However, this point is highlighted in paragraph 31. We propose IFSB to reword the Principle 3.2 to “A stress testing programme should be an integral part of an IIFS’s risk management framework, as well as business and strategic planning process and be supported by…….” PIDM
the Principle is consistent with the BCBS and CEBS. In addition, stress testing should be integral part of the risk management and its output should be used for business and strategic planning process as required under Pillar 2 by supervisory review process. The point that has been highlighted in the Paragraph 31 is about the results or output.
113.
Stress testing is an integral part of our risk management framework
At MAR, stress testing is an integral part of our risk management framework and we regularly engage with QCB in carrying out stress testing on majority of our assets both udder normal as well as stress conditions. For example we periodically carry our stress testing on our real estate portfolio and also measure the impact on the Bank’s capital adequacy, liquidity and profitability. MAR
No change. Noted.
114.
Paragraph 32 - The BOD and senior management should foster a culture within the IIFS that promotes stress testing as an important risk management tool by integrating it into its IIFS’s risk management processes. This requires the existence of an organisational structure in IIFS for stress testing. ………
Usually stress tests would be under the purview of an IIFS’ risk department. As long as there is a clear reporting line and governance structure that cascades stress test exercises upwards to the bank’s senior management and BOD for deliberation and approval, can we take it that this in effect fulfils the requirement of an “organizational structure in IIFS for stress testing.” ARBM
No change. Yes IIFS will comply with this recommendation, as long as there is a clear reporting line and governance structure that cascades stress test exercises upwards to the bank’s senior management and BOD for deliberation and approval.
115.
Paragraph 35 - ….. The Survey revealed that stress testing is an integral part of the overall
The guidance notes should only highlight the expectations towards the IIFS regardless of IIFS current status of implementation. Therefore may
Agreed. The Survey related findings which were presented in the last Paragraph of this Principle have been
54
governance and risk management culture of the IIFS. However, some of the IIFS have also demonstrated, inter alia, that: (i) they are in the process of integrating results with business and strategic planning; (ii) they have just developed risk management standard operating procedures for their IIFS as they spin off from conventional banks/groups; (iii) stress testing is done as part of a consolidated stress test done by conventional banks; (iv) stress testing is done for a conventional bank as a whole, not separately for IIFS; and (v) they are considering introducing stress testing as part of the ICAAP.
consider removing line 6, para 35 or incorporate the findings into Section 1.3: stock taking initiative. BNM
inserted in the beginning of the Principle through a footnote thus putting more emphasis on expectation towards the IIFS regardless of IIFS current status of implementation. This is also consistent with other Principles where the draft has used the findings in the footnote. See Paragraph 32.
Principle 3.3: IIFS should operate a stress testing programme that promotes risk identification and control and provides a complementary risk perspective to other risk management tools. Stress testing programmes should take account of views from across the organisation, including the Governance Committee (or an equivalent committee) and Sharī̀ ah supervisory board, and should cover a range of perspectives and techniques. 116.
Principle 3.3
We are agreeable to the Principle. AIB
No change. Noted.
117.
Principle 3.3
We are of the opinion that stress testing programmes should be left to the Governance Committee and/or the Board of Director, instead of the Shari’ah Committee Board (SCB). However, SCB may assists related parties involved in the stress testing programme on Shari’ah matters e.g. provide the necessary assistance to the requesting party so that various aspects pertaining to Shari’ah
No change. This is important and this involvement will ensure that all aspects of Sharī̀ ah compliance are appropriately addressed so as to avoid any doubt with regard to the Sharī̀ ah aspects. The ED does not require the involvement of SSB in terms of reviewing and defining the
55
non-compliance risk that may lead to legal and reputational risk are included in the stress testing programme. MBM
stress testing framework rather ED identifies places where the involvement of SSB is important and inevitable during stress testing process (e.g. Sharī`ah non-compliance risk). See also response in (122) below.
118.
Principle 3.3
We also agree this principle. Our primary objective in implementing our stress test is to identify the capital and funding and liquidity consequences of extreme but plausible events. We have developed the capability to conduct our stress tests at the Group level as well as at the level of significant subsidiaries both in Kuwait and abroad. KFHK
No change. Noted.
119.
Principle 3.3
Although stress testing could be a parallel tool for risk identification and quantification in addition to VaR, sensitivity & regression analysis etc but banks know that stress testing results are based on the type of scenarios taken - the more extreme scenarios taken, the more adverse results would be and more capital might be required. Would banks be ready to allocate capital based on these results or prefer VaR or other historical data based models for capital allocation? A clear guideline with cost – benefit analysis might be needed to pursue banks in adopting stress testing as a supplementary risk perspective for provisioning, capital allocation or reserve / buffer creation. WB
No change. Each IIFS should make its own assessment of the stress testing programme and related cost-benefit analysis. However, the costs must be weighed against the potential loss mitigation, the value of the information and risk control gained, and the capital management that will result from an effective, well-designed stress testing programme. Such a programme would enable the IIFS to better understand its risk profile, improve its portfolio management practices, and avoid making costly errors in credit decisions in the future by modifying key practices and improving risk identification.
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120.
Principle 3.3
We agree with this principle. We recommend a proper framework to be established for collaboration/communication between risk management department and Shari’ah supervisory board. Wan
Agreed. This is important for SSB and other departments to work closely through an established platform. This requirement has been reflected in the Paragraph 39 under Principle 3.3 now.
121.
Paragraph 37 – Stress testing should provide a complementary and independent risk perspective to other risk management tools such as value-at-risk (VaR), economic capital, and various statistical measures (such as correlation and multiple regression analysis….
Stress testing is yet another tool in the risk management framework of any financial institution. It is intended to provide a complementary and independent risk perspective to other risk management tools. Over emphasising its role may lead to over regulation, in the form of prescribed frequencies of tests and costly review process. IIB
No change. The ED does recognise this fact and has addressed in various Paragraphs of the draft. Certainly developing and executing an effective stress testing programme would be costly, however, the costs must be weighed against the potential loss mitigation, the value of the information and risk control gained, and the capital management that will result from an effective, well-designed stress testing programme.
122.
Paragraph 38 - The stress testing programmes should take account of views from across the organisation…..in order to achieve comprehensive coverage... A stress testing programme should ensure that the opinions of all relevant experts and specific organs (such as the Governance Committee and Sharī̀ ah Supervisory Board (SSB)) are taken into account, in particular for IIFS-wide stress tests covering, among other matters, those related to Sharī̀ ah non-compliance risk
The Exposure-Draft requires the involvement of the Sharī̀ ah Supervisory Board (SSB) in reviewing and defining the stress-testing framework in banks: we believe that this is not practical since using statistical models have nothing to do with Sharī̀ ah and the fact that members of the SSB may not be able to comprehend complex statistical concept. Accordingly the role of the SSB should be clearly defined. Instead, this can be delegated to the Risk Committee of the Board in coordination with Corporate Governance Committee. It is to be noted that as per IFSB's Sharī̀ ah Governance regulations (as well as CBB's HC-Module) requires that a member of Sharī̀ ah Supervisory Board be present/member in the Corporate Governance
Agreed. Clarification is added in the Paragraph 42 Principle 3.4 and in 3.15 to clarify the role of SSB in stress testing. The ED does not require the involvement of SSB in terms of reviewing and defining the stress testing framework rather ED identifies places where the involvement of SSB is important and inevitable during stress testing process (e.g. Sharī̀ ah non-compliance risk).
57
Committee. ITB
Certainly it is outside the scope of the SSB to define and review whole stress testing framework rather to provide their opinions where it is necessary and this has been highlighted in the Principle 3.3. The ED states that a stress testing programme should ensure that the opinions of all relevant experts and specific organs (such as the Governance Committee and Sharī`ah Supervisory Board (SSB)) are taken into account, in particular for IIFS-wide stress tests covering, among other matters, those related to Sharī̀ ah non-compliance risk and unrestricted IAHs-related stress testing. In addition, the roles of the SSB with respect to their involvement are defined in the paragraph 39.
123.
……
IFSB should provide further detail on the expectation of Shariah Supervisory Board (SBB) participation in the stress testing framework. The following is recommended:
• SSB should be expected to provide value added comments to the stress testing program,
• SSB composition should comprise both Shari’ah and banking background.
IFSB should look to provide principle for supervisory authorities to have an overall framework in assessing the SSB to ensure its role is played
Agreed on substance but not on the suggestions. The details of expectations with respect to SSB are updated in the Paragraph 42. However, it should be clear that it is beyond the scope of ED and the IFSB to recommend composition of SSB. IIFS should be referred to “fit and proper criteria” provided by their respective supervisory authorities. For supervisory authorities to assess SSB’s involvement, this issue has
58
effectively (which includes its participation in the stress testing program). BNM
already been addressed in Principle 4.1.
124.
This is currently over and above prevailing stress testing guidelines and is not being performed. SCS
No. change. The involvement of the SSB is part of the taking into account the views from across the organisation in order to achieve comprehensive coverage. See response above (122).
125.
This is currently over and above prevailing stress testing guidelines and is not being performed. SCS
No change. This is important and it is one of the significant specificities of IIFS, which should be taken into account. This involvement will ensure that all aspects of Sharī̀ ah compliance are appropriately addressed so as to avoid any doubt with regard to the Sharī̀ ah aspects. See also response in (122) above.
126.
Paragraph 39 - …….. In addition, in preparing written policies and executing action plans as a result of the stress testing exercise, the SSB should be consulted to ensure that all aspects of Sharī̀ ah compliance are appropriately addressed so as to avoid any doubt with regard to the Sharī̀ ah aspect. ………
Paragraph only provides for consultation of the Sharia Board to ensure that all aspects of the Sharia compliance are appropriately addressed. We understand that any such consultation should be followed by formal approval of the Sharia Board as well as a certification by the Sharia Board that all such aspects including the aspect of Sharia non-compliance have already been addressed. DIB
No change. This is addressed in the Principle 3.3 and Principle 3.4, see Paragraph 39 and 42.
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Principle 3.4: IIFS should have: (i) written policies and procedures, (ii) clear responsibilities, and (iii) allocated resources to facilitate the implementation of the stress testing programme. The operation of the programme should be appropriately documented at all levels. 127.
Principle 3.4
Agreed. There should be written Policy & procedures for stress testing. AIB
No change. Noted.
128.
Principle 3.4
These are duly complied with and documented in our Maybank Group Stress Testing Framework. MBM
No change. Noted.
129.
Principle 3.4: This has been prescribed in the Bank’s Market Risk Management Policy.
Wan
No change. Noted.
130.
Principle 3.4
We agree this principle. KFHK
No change. Noted.
131.
Principle 3.4
As asked, banks would need clear written policies, procedures and processes for successful implementation of stress testing framework. WB
No change. Noted.
Principle 3.5: An IIFS should regularly review its stress testing framework and assess its effectiveness and robustness regularly and independently.
132.
Principle 3.5
Agreed. Internal audit or other competent party could independently assess the effectiveness and
No change. Noted.
60
robustness of the stress testing framework. AIB
133.
Principle 3.5
Principle 3.5: This has been prescribed in the Market Risk Management Policy.
Wan
No change. Noted.
134.
Principle 3.5
The above is complied with as our Maybank Group Stress Testing Framework is being reviewed annually. The framework is also being reviewed independently by internal audit. MBM
No change. Noted.
135.
Principle 3.5
Principle 3.5 provides the regularity of review of the stress testing program. It provides further the review and consideration of stress scenarios used to ensure that the framework is up to date. We support the need for periodic and continuing review to ensure that the stress tests are valid, viable and illustrative. Nonetheless, we simply wish to reiterate the issues already pointed above, i.e., that there may be issues if the latter is left to rate its own institution. BSNP
No change. Noted.
136.
Principle 3.5
We also agree this principle. The development of the new stress testing capability at KFH was motivated by the assessment of limitations in our previous stress testing capability. We will continue
No change. Noted.
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to review our stress testing framework. KFHK
137.
Principle 3.5
As proposed, a back-testing program should run in parallel to assess effectiveness of bank’s stress testing framework. WB
No change. Noted.
138.
Principle 3.5
The scope of "independent" mentioned within Principle 3.5 must be defined. Due to a lack of specification we suggest either deleting the term "independently" or, at least, it should be clarified that the internal audit can be seen as independent within the meaning of this Principle. ITB
No change. This has already been addressed in the Paragraph 45 under Principle 3.5. The text under the Principle 3.5 states that …since the stress test development and execution processes often imply judgemental and expert decisions (e.g. assumptions to be tested, calibration of the stress, etc.), an independent control function such as risk management and internal audit should play a key role in the process.
139.
Principle 3.5
The ED is robust and covers most of the important areas. It gives good coverage to the importance of the involvement of the BOD in stress testing. However, we are of the opinion that Principle 3.5, which discusses regular review of the stress testing framework, did not state how regular the testing should be. There should be a maximum interval between one test and another. CBN
No change. The frequency of assessment of different parts of the stress testing programme should be set appropriately by IIFS.
140.
Para. 41 - The effectiveness and
Maintaining and updating the stress-test system
No change. The term “regularly” has
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robustness of stress tests should be assessed regularly, qualitatively as well as quantitatively, given the importance of judgements and the severity of shocks considered, and in light of changing external conditions, to ensure that they are up to date. The frequency of assessment of different parts of the stress testing programme should be set appropriately by IIFS. ……
strongly depends on the bank's business model. Hence, under paragraph 41 we suggest replacing the language "regularly" by "in appropriate intervals". ITB
already been defined in the Paragraph 44 (which is consistent with other Principles). This Paragraph 44 suggests that the frequency of assessment of different parts of the stress testing programme should be set appropriately by IIFS. Therefore, it should be noted that the suggested term “in appropriate intervals” is already being implied and addressed within the term “regularly” in the Paragraph 44.
Principle 3.6: An IIFS should identify and cover in its stress testing programme a range of relevant material risks to which an IIFS is, or is likely to become, exposed, both at the business unit level and the IIFS level. An IIFS should be able to integrate effectively and meaningfully in the stress testing activities all the risks and business areas, taking into account possible risk correlations, in order to deliver a complete picture of IIFS-wide risk. 141.
Principle 3.6
We take note in improving identification of possible risk correlations. AIB
No change. Noted.
142.
Principle 3.6
Principle 3.6: This has been prescribed in the Market Risk Management Policy.
Wan
No change. Noted.
143.
Principle 3.6
Will take into consideration the other specific risks (e.g. Shari`ah non-compliance risk, equity investment risk and rate of return risk). MBM
No change. Noted.
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144. Principle 3.6 Principle 3.6 on the list of risk elements could include name concentration. IMF
No change. The Principle 3.6 does not specifically discuss the risk concentration, rather risk concentrations is discussed within general risk factors. See Paragraphs 48 and 61.
145.
Principle 3.6
We agree this principle and have taken steps in our stress testing framework to adopt it. KFHK
No change. Noted.
146.
Principle 3.6
Although it is suggested to cover all material risks in stress testing but sometimes risks such as reputational, regulatory or other operational risks might not be easily stress tested and thus might not be easy to allocate capital. WB
No change. See response in (148) below.
147.
Principle 3.6
IFSB guidelines suggests risk interactions and the relevant correlations at the risk category level (For example Market risk or credit Risk) to be assessed during stress testing. Research is very limited in the area of assessing interactions between various risks and inclusion of such factors for stress testing. Only estimation at a broad level can be included currently in the absence of relevant infrastructure and guidelines. AU
No change. IIFS are expected to start collecting data and conducting necessary research to effectively implement various stress testing aspects in the practice. The issue of correlations is very important and should be addressed as it is one of the necessary ingredients in the scenario analyses, which is one of the important stress testing methodologies.
148.
Principle 3.6
To guide the IIFS in measuring the risk factors or other types of risk that are qualitative in nature and cannot be fully quantified (i.e. some types of operational risk such as legislative risk, Shariah
No change. The ED does not aim to provide and suggest any particular methodologies for measuring these qualitative factors as they will vary
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non-compliance risk, reputational risk and strategic risk). BPMB
from IIFS to another IIFS. This is left to the IIFS to employ, whether internally developed with the help of consultant or outsourced. Regarding the quantification, the ED does recognises the challenging task of quantifying the potential impact of Sharī`ah non-compliance risk leading to legal and related reputational risk by the IIFS, however, in this regard, IIFS are guided through number of aspects listed under Paragraphs 113 an 114. To mitigate reputational spillover effects and maintain market confidence, an IIFS should develop their own methodologies to measure the effect of reputational risk on other risk types, with a particular focus on credit, liquidity and market risks.
149.
Paragraph 44- When constructing the stress tests, the general risk factors that the IIFS should consider may include, inter alia: (i) macroeconomic factors (e.g. foreign exchange rates, inflation, GDP growth, unemployment rate, asset prices; (ii) geographical and political factors (i.e. health of other economies, vulnerabilities to external events, and contagion effects); (iii) financial market conditions (i.e. both funding and market liquidity); (iv) risk
We understand that the main channels from external shocks to Islamic banks are low oil prices, tight global liquidity conditions, decline in asset prices (equity and real estate) and volatility in exchanges and interest rates. It would be useful if the list of general risk factors listed in para.44 includes oil prices. In the same vein, volatility in interest rates should be tested. IMF
Agreed. The list of general risk factors listed in Para.48 has been updated to reflect the suggestion of the IMF.
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concentrations…….. 150.
Paragraph 45 - In addition to the traditional banking risks (such as credit risk, market risk and liquidity risk), IIFS are also exposed to other specific risks (e.g. Sharī̀ ah non-compliance risk, equity investment risk and rate of return risk) as outlined in IFSB-1. …. (i) credit risk for Sukūk, for real estate financing, and for other exposures; (ii) market risk for equities, Sukūk, real estate investment, foreign exchange and other exposures; (iii) investment risk for Muḍārabah and Mushārakah; (iv) liquidity risk; (v) rate of return risk; (vi) displaced commercial risk; and (vii) operational risk, including Sharī̀ ah non-compliance risk, fiduciary risk, reputational risk and legal risk. ….
We are of the opinion that the guidelines are to be included regarding the qualities of the stress scenarios that will be established as to the Shari’ah-conformity risk, guarantor risk, credibility risk and legal risk, which are mentioned within the coverage of operational risks and how the results thereof shall be assessed. CBRT
No change. See Principle 3.15.
151.
Paragraph 46 - An IIFS should not confine the stress testing exercises only to regular risk factors that it faces (such as market risk, liquidity risk, credit risk, etc.); it should also take into account certain qualitative risk factors or other types of risk that are more qualitative in nature which cannot be measured exactly (i.e. some types of operational risk, such as legislative risk, Sharī̀ ah non-compliance risk, as well as
Qualitative risk factors are currently not tested. Due to their subjective nature, it may be prove difficult to use such factors as a basis of comparison. SCS
No change. The IFSB understands the difficulty of quantifying these risks; however, the importance of these risks have been increased in recent times, therefore, an IIFS should not confine the stress testing exercises only to regular risk factors that it faces rather they should find ways how they can impact them. Principle 3.15 provides guidance on the potential risk factors (qualitative and quantitative) pertaining to Sharī̀ ah
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non-compliance risk (which is one of the qualitative risk factors), leading to legal and related reputational risk that should be included in an IIFS’s stress testing as failures in Sharī̀ ah compliance could severely damage the reputation of an IIFS.
152.
reputational risk and strategic risk). ….
Also, we think the guidelines are to be stated as to what some qualitative risk factors, as exemplified by the aforesaid risk types, might be as well as the features of the stress tests that could be applied to these risk factors. CBRT
No change. It is already addressed in the ED. See Paragraph 50 and Principle 3.15 of the revised ED for more detail on this issue.
Principle 3.7: A stress testing programme should cover a broad range of scenarios (including “dynamic and forward-looking scenarios”), and aim to take into account system-wide interactions, feedback effects, and dynamics. IIFS should identify appropriate and meaningful mechanisms for translating scenarios into relevant internal risk parameters that provide an IIFS-wide view of risks.
153.
Principle 3.7
We are agreeable to the Principle. AIB
No change. Noted.
154.
Principle 3.7
The Market Risk Management Policy covers the “dynamic and forward-looking scenarios” stress testing.
Wan
No change. Noted.
155.
Principle 3.7
This has been the practice of Maybank and complied. MBM
No change. Noted.
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156.
Principle 3.7
The mechanisms for generating an Enterprise-wide view of risks through stress testing will differ from institution reflecting the relative levels of complexity in their business, including overseas activity, and the availability of data and modeling capabilities that generate results that make sense. The methods for mapping economic and financial sector shocks onto a Bank’s Balance sheet, P&L and cash flow are complex. Data driven analysis using univariate or multivariate regressions are influenced by the availability of these data and how the bank has responded to such shocks in the past. Techniques such as Monte Carlo simulation have a role in testing the parametric assumptions of VaR models or estimating operational risk. Extreme value theory makes certain assumptions about the distribution of losses in excess of the target threshold that may also not be testable due to a) lack of data or b) lack of response to such shocks in the past. We form the view that the limitations of any statistical methods be subject to sound judgment and, in some circumstances, management override. We recognize the need to encompass this into a well governed framework to mitigate the dangers of bias influencing the decisions made on foot of the analysis of the results. KFHK
No change. Noted.
157.
Principle 3.7
As always preferred, stress testing should cover wide-ranging scenarios but it might not always be easy in reality. Banks cannot reserve capital for all possible risks. Banks work on probability and severity. A less probable but highly severe risk might not be given as much weight as high probable but less severe risk or vice versa. Stress testing
No change. It might be the case at WB, but this is not what the ED has suggested. In fact in order to design the stress testing, the ED has recommended to IIFS the need of taking into account exceptional but plausible events” or “low-frequency–
68
framework would require an exact strategy to handle this. WB
high-impact events which may not be reflected in historical data and taking into account new concentrations of risks that may emerge, contagion effect and the failure of hedging techniques. It should be noted that exceptional events or “low-frequency–high-impact events would be fairly rare and have a large magnitude or impact on the portfolio to be stress tested. Plausible events cannot be so extreme that no IIFS would withstand such a shock or they have zero probability of occurring. See Principle 3.8 for more detail.
158.
Principle 3.7
We recommend IFSB to provide more clarity on the framework or methodology on inclusion of second round effects, contagion effects and feedback effects in the stress testing framework. AU
No change. The specific methodology to determine the relevance of the second-order effects to its business, and to link the second-layer risk elements to the first-layer risk factors, is left to the IIFS. The IFSB acknowledges the challenges of incorporating these second-round effects and understanding the complexity of the links between the scenarios. However, an IIFS may wish to consider the second-round effects via their impact on macroeconomic factors. IIFS should note that certain macroeconomic factors that may not have been directly affected by the original shock may be affected by the consequences of that shock (i.e. when one event subsequently triggers
69
another event, requiring IIFS to include “correlation and multi-correlation” analysis in the stress testing). See Paragraph 67 of the revised ED.
159.
Principle 3.7
The other factor that needs to be looked at while choosing the scenarios for stress testing should neither be very conservative nor too rigid to avoid conflict of interest between profit centers and the risky ventures. Moreover, the above decision has its roots embedded in the risk appetite of an institution which fairly varies on one to one basis. BAP
No change. This is addressed in detail in Principle 3.7. Chosen scenarios has to be relevant and within the risk appetite of an IIFS.
160.
Principle 3.7 – Para. 50 on p. 18 - …..The effectiveness of stress testing depends, in particular, on the extent to which an IIFS chooses and constructs the right scenarios for stress tests. Scenarios should be simple, comprehensible and easy to explain, yet they need to be realistic and relevant. For an IIFS, it is not enough just to generate scenarios; they need also to be simulated (possibly through “fire drills”) in the context of the organisation.)
The wording of para. 50 seems to imply that IIFS should conduct role-playing exercises similar to drills on business continuity plans. Principle 3.7 requires that a stress testing programme should cover a broad range of scenarios and aim to take into account system-wide interactions, feedback effects, and dynamics, and Principle 3.17 states that a stress scenario can be a historical scenario or a hypothetical one based on expert judgement (para. 106). Given such applicable requirements for stress scenarios, it would seem difficult if not impossible for IIFS to “simulate” in real life such scenarios. It would be helpful if the IFSB could elaborate on the rationale for, and the benefits of, this requirement, and provide technical guidance on the approaches and methodologies with which IIFS can comply with it. HKMA
No change. If a particular scenario cannot be simulated in the context of the organisation, then certainly the applicability of such scenario could be questioned and accordingly the outcomes of such scenario might be misleading. Therefore, the ED suggests the usage of “fire drills”, so that the actual scenario could produce accurate results, however, an IIFS can chose to simulate using any other mechanism as long as it serves the intended purpose.
In addition, the recent financial crisis (2008) has indicated that the scenarios undertaken by the financial institutions were not severe, indicating
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the possibility of simulating them. The IFSB does not intend to prescribe particular approaches which IIFS can employ rather it is left up to the IIFS to choose appropriate methodologies which suit their them taking into account the cost factor. However, supervisory authorities may wish to provide those methodologies to IIFS, in which IIFS can comply with.
The Para.55 also states that while it is difficult to identify an optimal number of scenarios, it is clear that the appropriate number will vary for different IIFS. Further, given that an infinite number of scenarios could be run, the total number needs to be limited, and an IIFS would need to balance maximising the coverage of the scenarios against managing the costs of running the scenarios and filtering results into a form that can be discussed and taken on board by the BOD and translated into action.
161.
Paragraph 51 - An effective stress testing programme should comprise scenarios along a spectrum of events and severity levels which will help to deepen management’s understanding of vulnerabilities. A range of scenarios covering products, range of risks (i.e. general risk factors, specific risks and.......In regard to who should provide the scenarios, it
The proposed guidelines require the stress test scenarios to be provided from the top management and Board. We are of the view it can also be done by business unit. This however should be subject to endorsement by top management and Board. This would encourage and facilitate more active risk management at all levels within each IIFS. HLIB
No change. This is already addressed in the Paragraph 56, in which the respective department heads can provide the scenario.
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could be done by one or a combination of the following (the list is not intended to be exhaustive): the BOD, senior management, the risk management committee or the BOD’s risk management committee (BRMC), the respective department heads, or the ALCO.
Principle 3.8: Stress testing should be based on “exceptional but plausible events” or “low frequency–high-impact events which may not be reflected in historical data”. The stress testing programme should identify different severities in each scenario (including scenarios which reflect a severe economic downturn) considered along with the assumptions damaging the reputation of an IIFS. An IIFS should also specify how its stress testing programme handles “second-round effects” and “fat tails extreme events” with respect to the unique risk factors threatening the viability of the IIFS. 162.
Principle 3.8
We are agreeable to the Principle. AIB
No change. Noted.
163.
Principle 3.8
Principle 3.8: This is also has been prescribed in the Market Risk Management Policy.
Wan
No change. Noted.
164.
Principle 3.8
This has been the practice of Maybank and complied. MBM
No change. Noted.
165.
Principle 3.8
We agree to this principle. KFHK
No change. Noted.
166.
Principle 3.8
Although IFSB suggests taking extreme and severe shocks in stress testing, usually not reflected in
No change. IIFS should have strategies approved in advance with
72
historical data but would banks be asked to allocate capital based on extreme results from those severe scenarios? WB
regard to the actions that would be taken based on the results of the stress test in identifying the points requiring remedial actions, such as those provided in the Paragraph 140. In addition, the BOD and senior management have responsibility for evaluating the relevant outputs from the stress testing programme, and for taking appropriate management actions while integrating stress testing outputs into the IIFS’s decision-making process. Further, under Principle 4.4, supervisory authorities should review the range of remedial actions envisaged by an IIFS in response to the results of the stress testing programme and be able to understand the rationale for senior management decisions to take or not to take remedial actions.
167.
Principle 3.8
Please clarify the statement “Stress testing should be based on “exceptional but plausible events” or “low frequency–high-impact events which may not be reflected in historical data”. As a clear guidance and standardization to the practitioner this can be best reflected in term of range of acceptable probability. BMMB
No change. Defining a range of acceptable probability in the ED with respect to “exceptional but plausible events” or “low frequency–high-impact events”, might appear misleading to certain IIFS and therefore it is left to the IIFS to formulate and define acceptable probability (or confidence interval) of certain events using qualitative and quantitative techniques together with expert judgement. It is also understandable that IIFS would have to strike a balance between too small probability (not useful) and too large probability (considered
73
unlikely/improbable). The ED also notes that exceptional events or “low-frequency–high-impact events would be fairly rare and have a large magnitude or impact on the portfolio to be stress tested. Plausible events cannot be so extreme that no IIFS would withstand such a shock or they have zero probability of occurring.
168.
Principle 3.8
To elaborate more on “exceptional but plausible events” or “low frequency–high-impact events which may not be reflected in historical data” as a clear guidance and standardization to the practitioner thus it can be reflected in term of range of acceptable probability. BPMB
No change. See response above in (167).
169.
Principle 3.8 – para. 56 on p.21 - ...Plausible events cannot be so extreme that no IIFS would withstand such a shock or they have zero probability of occurring) and para. 60 on p.22 (All stress testing scenarios should be accompanied by an indication of the estimated probability of the event occurring.)
It is recommended that the IFSB re-consider maintaining the implicit or explicit requirements in paras. 56 and 60 that IIFS should estimate for all stress scenarios the probability of the event occurring. As stated in the BCBS’s stress testing guidance (May 2009), “The financial crisis has shown that estimating ex-ante the probabilities of stress events is problematic. The statistical relationships used to derive the probability tend to break down in stressed conditions.” (4th para. Under Principle 8, p.13). In addition, it could be technically-daunting for IIFS to provide ex-ante estimates for all stress scenarios the probability of the event occurring (if IIFS are to do this, supervisors would surely expect their estimates to be supported by sound and robust assumptions, data, modelling, analyses,
Agreed. The Para. 71 has been reworded by removing the word “all” and replacing with “relevant and plausible stress testing scenarios with a forward looking perspective” which should be accompanied by an indication of the estimated probability of the event occurring. One footnote has been inserted in the Para.71 justifying the inclusion of an indication of the estimated probability of the event occurring. In addition, a reference to 4th para. Under Principle 8, p.13 of BCBS has been updated in the Para. 71 of the ED.
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justifications and documentations, etc) but it may not be prudent or appropriate to rely on the probability numbers so determined. Various post mortem studies on the global financial crisis revealed that many financial institutions, including sophisticated ones, had under-estimated the severity or the degree of interaction across portfolios or risk types. A low probability number for the more severe stress scenarios may even risk misleading the BOD or senior management of an IIFS to attach low importance to such scenarios and the implications of the related stress test results, undermining the effectiveness and usefulness of stress testing. HKMA
170.
Paragraph 59 - …… An IIFS should capture the second-round effects that might arise from the original shock (e.g. the increase in real estate prices is likely to affect the retail consumers’ and investors’ debt servicing capability as well as the property sector) ………
The example used on the second round effects might not be accurate. It is not clear how increase in real estate prices would result in deteriorated debt servicing capability. Decrease in real estate prices could drive lower recovery rate, hence higher credit losses, given a default. BNM
Agreed. It should be “decrease in real estate”. The example is revised.
171.
Paragraph 60 - “Distributions are said to have “fat tails” when extreme events that would appear highly unlikely according to a normal probability distribution are shown as being substantially more likely…”
“Fat tail” distribution is a common concern in market risk assessment. In credit risk assessment, shift in the distribution or in other words “skewed distribution” is normally the concern. IFSB may want to reflect this for credit risk aspect. BNM
Agreed. The suggested credit aspect has been added in the Principle 3.11. See Paragraph 84(e).
172.
Paragraph 61 - Given the specificities of IIFS, as part of an
The recommendation on stress test to cover Shari’ah non-compliant risk would require both
No change. The IFSB understands
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qualitative and quantitative measurements. Recommend IFSB to supplement the requirement with Practice Notes for IIFS to adopt/implement. HLIB
the difficulty of quantifying this risk; however, the importance of quantifying this risk has increased in recent times as noted in the Paragraph 112 and footnote 54. Principle 3.15 provides guidance on the potential risk factors (qualitative and quantitative) pertaining to Sharī̀ ah non-compliance risk (which is one of the qualitative risk factors), leading to legal and related reputational risk that should be included in an IIFS’s stress testing as failures in Sharī̀ ah compliance could severely damage the reputation of an IIFS. With respect to Practice Note, see responses in (9) and (10) above.
173.
overall stress testing programme an IIFS should aim to take account of specific elements in the programme…...The specific elements that require stress testing coverage which must be covered in the stress testing programme include, but are not limited to, the following: (i) funding composition, including IAHs; (ii) various perspectives on capital adequacy; (iii) credit risk factors and the effectiveness of Shari`ah-compliant risk mitigation techniques; (iv) market risk factors, including Shari`ah-compliant securitisation; (v) specific portfolios; (vi) liquidity risk factors and various unique perspectives; (vii) Shari`ah non-compliance risk leading to legal and related reputational risk…… …..However, IIFS should consider the range of scenarios with different severities and appropriate magnitudes of shocks for these elements in the stress testing methodologies employed at the IIFS level.
Further, we deem it is necessary to specify what the techniques for the minimization of the Shari’ah-compatibility risk mentioned in the concerned paragraph are as well as what is actually implied with the term 'Specific Portfolio '. CBRT
No change. This is explained in the Principle 3.13.
Principle 3.9: An IIFS should include in its stress testing programme the specific scenarios to account for the various perspectives of profit sharing IAHs, unrestricted IAHs and, in some circumstances, restricted IAHs. The Governance Committee (or an equivalent committee) as an integral part of the overall governance for the stress testing programme should be involved when developing stress scenarios related to IAHs and subsequently assessing the results of stress testing on the IAHs. 174.
We are agreeable to the Principle.
No change. Noted.
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AIB 175.
Important scenario to consider for IIFS in understanding the impact on its liquidity. OCBCA
No change. Noted.
176.
Principle 3.9
It would be useful to clarify why off-balance sheet “restricted” accounts, which are large in the sector, would be added only under some circumstances to the exercise (Principle 3.9). Is this something specific to Islamic banking? IMF
No change. The Principle 3.9 explicitly covers the issues pertaining to unrestricted IAHs funds which are commingled with those financed by the IIFSs’ own funds, current accounts, etc. In contrast, restricted IAHs are separate managed funds which are not commingled with other funds of the IIFS. Shocks to the assets of these funds will generally not have the same repercussions as shocks to those of unrestricted IAHs. Further, in principle, in the absence of misconduct or negligence on the part of the IIFS, stress events affecting restricted PSIA concern the IAHs and not the IIFS itself, except to the extent that the IIFS’s income from managing the restricted PSIA may be in jeopardy (which should be included in the stress testing). By contrast, in the case of unrestricted PSIA, the funds are typically commingled with other funds on the IIFS’s balance sheet and stress events affecting the PSIA affect the IIFS as a whole.
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177.
In a Shari’ah-compliant banking system, supervisors may also want to test the ability of banks to discharge their obligations to investment account holders (IAH). In a conventional banking system, the danger of widespread default on customers’ deposits (an event which would have major social/public policy implications) is addressed through deposit insurance. This is less likely to be the case in a Shari’ah-compliant system. Within a Shari’ah-compliant banking system, the stress tests should therefore examine the ability of banks to discharge their obligations to IAH as well as their regulatory requirements. In a mixed system, Shari’ah-compliant banks should be subject to this additional level of scrutiny. Supervisors should require Shari’ah-compliant banks to incorporate this additional level in their own stress testing methodologies. Andrew
No change. Agreed with comment. Various IAH related stress testing aspects are addressed specifically in the Principle 4.1, which capture the IAH related stress testing. With respect to supervisory assessment and review on this issue, it has been addressed in the Principle 4.1 under Section 4 (which is on supervisory stress testing).
178.
Principle 3.9
Currently most of the IIFS in the region are not doing this; if the same is regulated, then process and system development will be required. DIB
No change. IIFS will be required to do once the guidelines are available from their respective supervisory authority.
180.
Principle 3.9
We also agree this principle and run our stress tests under different assumptions regarding profit sharing with Investment Account Holders. KFHK
No change. Noted.
181.
Principle 3.9
As suggested, stress testing program should no
78
doubt include stress testing deposit holders including restricted IAHs, their behavior, their historical attitude etc. WB
No change. Noted.
182.
Principle 3.9
Majority of the Islamic banks absorb a proportion of losses normally borne by Investment Account Holders (IAH) in order to mitigate potential massive withdrawal of funds. This practice exposes Islamic banks to a specific risk, called displaced commercial risk (DCR) which requires allocating adequate capital to cover losses. When developing the stress scenarios related to Displaced Commercial Risk (DCR), the bank should assess the result of the stress test that may have negative impact on the bank instead of assessing the results of stress testing on the IAHs. MBM
Agreed. The Paragraph 75 under Principle 3.9 has been updated to reflect this suggestion.
183.
Paras. 63 and 64 regarding IAH risk absorbent and income smoothing
The ED should consider expanding the discussions in paras. 63 and 64 regarding IAH risk absorbent and income smoothing, which would be quite useful given the importance of these two issues for IBs. Examples in this regard about how these two topics could be dealt with in practice would be quite useful for the users of the guiding principles. IMF
No change. The objective of this ED is not to explain and expand the discussions on the IAH risk absorbent and income smoothing as these issues are already addressed in detail by the IFSB in the Guidance Note on the Practice of Smoothing the Profits Payout to IAHs (GN-3)”. Therefore, IIFS should refer to GN-3, and this ED has made cross-reference to GN-3 for the purpose of completeness.
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Principle 3.10: An IIFS’s stress testing programme should include a sufficient element of capital assessment, capturing various unique perspectives at all times under the defined scenarios. IIFS should evaluate the reliability of their capital planning (including the assumptions used) based on stress test results. Stress tests under ICAAP should be consistent with an IIFS’s risk appetite and strategy, and incorporate credible mitigating management actions. IIFS should assess and be able to demonstrate their ability to remain above the regulatory minimum capital requirements during a stress situation that is consistent with their stated risk appetite.
184.
Principle 3.10
Agreed. We have considered the stress test results in our capital planning activities. AIB
No change. Noted.
185.
Principle 3.10
This has been the practice of Maybank and complied. MBM
No change. Noted.
186.
Footnote 35 in para.68 (……If “alpha” is 0, then all RWA corresponding to the unrestricted IAH funds are excluded from the denominator. If “alpha“ is 1, then traditional CAR applies, with CAR applying to all on-balance sheet assets.)
The note might want to clarify what “traditional CAR” (footnote 35) is, and whether the working hurdle rates would be agreed in advance. IMF
Agreed. This footnote has been revised addressing the issue of “Alpha”. The revised footnote 38 adopts the definition of “Alpha” taken from GN-4 and makes cross-reference to GN-4 for more detail on the estimation of values of alpha, whether “alpha” is 1 or 0, or between 0 and 1. Thus the reference to “Traditional CAR” (i.e. Basel Formula of CAR) has been removed.
187.
Paragraph 71 - linking stress-testing with capital requirements (ICAAP)
We also draw attention that linking stress-testing with capital requirements (ICAAP) may eventually result in double-counting the effect of "Buffer Requirements" under the soon-to-be-implemented Basel III requirements. If capital must be increased as a result of stress-testing and at the same time as a result of Buffer requirement (which already increases the minimum CAR thresholds under
No Change. The ED does not see this to happen. Stress testing is an integral part of the ICAAP. Actually, the various “buffer requirements” as stipulated in the Basel III supplement/strengthen the capital framework of IIFS. Therefore, these buffer requirements could be subject
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Basel III), banks will definitely end up over-capitalized resulting in inefficient utilization of capital. ITB
to stress testing, however, the results of such stress testing may be discussed in parallel with regulatory and economic capital stress testing. One has to distinguish between “regulatory capital” and “economic capital”. The former is to be captured in the stress testing through the various factors mentioned in the Guiding Principles (and requirement of regulatory capital will be same across the IIFS) and the latter to be captured in the stress testing through ICAAP (and requirement of economic capital will be different across the IIFS). More detail on ICAAP will be discussed in the revised Supervisory Review Process (IFSB-5).
188.
Principle 3.10
We conduct our stress testing in support of ICAAP in accordance with this principle. KFHK
No change. Noted.
189.
Principle 3.10
Capital planning based on stress testing is ideal but difficult and sometimes not possible unless banks are given defined scenarios and parameters. Leaving capital planning as well as scenario selection on banks might create a variety of regimes. No doubt capital allocation should cover ICAAP, risk appetite etc in addition to minimum regulatory capital. WB
No change. IIFS are expected to generate their own IIFS specific scenarios together with the guidance provided by the respective supervisory authority. See Principle 3.7 and Section 2.5.
190.
Paragraph 71 - linking stress-
As also laid down in Basel III, banks need capital
No change. Noted.
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testing with capital requirements (ICAAP)
based on forward looking risk assessment including provisioning on credit portfolios. Basel’s requirement to maintain capital based on Pillar II or ICAAP in addition to minimum regulatory capital is on the premise that banks assess risks from possible extreme shocks which are usually ignored in Pillar I. WB
191.
Paragraph 71 - linking stress-testing with capital requirements (ICAAP)
Benchmarking and treatment, ….becomes an issue especially when considering the requirements of (a) Principle 3.8 which states that Stress testing should be based on "exceptional but plausible events" or " low frequency high-impact events which may not be reflected in historical data", and (b) Principle 3.10 which links stress-test with ICAAP. As stress-test results will always be unfavorable, we suggest, for the avoidance of future misunderstandings, that the Exposure-Draft should clearly spell out that the consideration of stress tests in the framework of capital requirements will not lead to a situation where additional capital requirement becomes compulsory by regulatory authority. Instead, the results of the stress-testing should only serve as indicative measures of the overall risk of banks and possible action plans. ITB
No change. Why would the results be unfavorable always? One of the main considerations in the stress testing framework is that it should be actionable. Further, the ED suggests (Paragraph 139) that IIFS should have strategies approved in advance with regard to the actions that would be taken based on the results of the stress test in identifying the points requiring remedial actions. In addition, the ED mentions that supervisory authorities should review the range of remedial actions envisaged by an IIFS in response to the results of the stress testing programme and be able to understand the rationale for senior management decisions to take or not to take remedial actions (Paragraph 170). And one of the measure taken by the supervisory authorities with respect to capital stress testing include among others things, the review of limits (e.g. requiring an IIFS to raise the level of
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capital above the minimum Pillar 1 requirement to ensure that it continues to meet its minimum capital requirements over the capital planning horizon during a stress period (Paragraph 173(b)).
Principle 3.11: An IIFS should take into account various aspects of credit risk in its stress testing techniques covering, inter alia, non-performing financing and highly leveraged counterparties, in order to determine the overall soundness of the IIFS, particularly in the case of economic downturns. Stress testing should assess future credit exposures and changes in capital requirements due to, for example, changes in credit quality and collateral values. It should also encompass securitisation exposures as originator, issuer, sponsor, manager, etc. as reflected by credit conversion factors (CCFs). The effectiveness of risk mitigation techniques that are Sharī̀ ah-compliant should be systematically challenged. 192.
Principle 3.11
Agreeable to the Principle above. The Bank will look into the assessment of future credit exposures. MBM
No change. Noted.
193.
Principle 3.11
Principle 3.11 recognizes that it may be difficult to stress the financing portfolio since this involves the use of variables such as the probability of default, recovery rates, and rating migration probabilities. In this regard, guidance may be provided on alternative means of conducting stress tests in the absence of such variables. BSNP
Agreed. The text in Paragraph 83 under Principle 3.11 has been updated to clarify that these variables are normally available to IIFS under non-standardised approach (e.g. IRB approach).
194.
Principle 3.11
We are agreeable to the Principle. AIB
No change. Noted.
195.
Principle 3.11
Principle 3.11 could refer expressly to name concentration, given that it is a very important risk in Islamic banking.
No change. Existing reference to credit risk factors is consistent with other principles such as market risk
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IMF
factors and liquidity risk factors. In addition, existing reference is also consistent with BCBS and CEBS guidelines. The term “risk concentrations” as an important risk is discussed within general risk factors. See Paragraph 48.
196.
Principle 3.11
The Follow-up Portfolio and such firms as are with high indebtedness should be subjected to different scenarios. Stress rests are also to be separately inclusive of the future risk increases of the customers, their differentiations in the guarantee values as well as the changes in firms' capitals. CBRT
No change. IIFS are expected to generate their own IIFS specific scenarios taking into account their size, complexity and nature of the business. The list of the aspects mentioned in the Principle 3.11, is not exhaustive, and it should be used as reference and therefore, IIFS can expand this list based on certain important aspects which are relevant and applicable to them.
197.
We form our assessment of credit risk under stress under a range of assumptions related to the quality of our financing portfolio. We aim to capture spillover effects from one portfolio to another. KFHK
No change. Noted.
198.
Stress testing for credit risk including forward looking provisioning / reserve creation for anticipated changes in counterparty credit quality and expected collateral downgrade could be quite subjective. WB
No change. See response above in (196).
199.
Principle 3.11
Lack of historical market information which can be
No change. Indeed, lack of an
84
used as a basis to improve the stress testing exercise at IIFS. For example, there is no corporate default history for the GCC markets or IIFS institutions as a whole which can be used to improve the stress testing at a credit portfolio levels. We recommend IFSB to collate such information from various institutions and provide the same to IIFS as this can lead to the formation of an effective benchmark for GCC and IIFS. AU
adequate database has been a major challenge for IIFS (as for many conventional banks) in conducting stress testing exercises, however, lack of the necessary data constitutes a management limitation that must be rectified within a reasonable period of time. The key is to start collecting data and enhance the representativeness of the distribution curve as time involves and in the interim add relevant proxy data to overcome data gaps. See Section 2.2 for more detail. Collating data is one of the areas in which the IFSB is working on, and expects that this may turn out to be a challenging exercise to provide corporate default data, which is subject to relevant IFSB member supervisory authority.
200.
The principle highlights consumer credit portfolio as an example for the stress test on specific portfolios. As an example, the consumer credit portfolio example seems to emphasise a narrow stress test scope of coverage. BNM
No Change. It depends on IIFS to another IIFS. In certain jurisdictions, the consumer credit portfolio is significant, where other portfolios are not significant. The IFSB notes that as the market develops, these examples may be replaced with new ones, or new portfolios may be considered in addition to existing portfolios that would need to be captured in the stress testing.
201.
Principle 3.11 - “An IIFS should take into account various aspects
In the Principle statement, suggest to reword to “potential additional non-performing financing and
No change. Non-performing financing (NPF) is more appropriate and
85
of credit risk in its stress testing techniques covering, inter alia, non-performing financing and highly leveraged counterparties…”
highly leveraged counterparties” BNM
comprehensive statement. Conducting stress testing on credit aspects, particularly with respect to NPF, the analysis will automatically include “potential additional NPF” as result of stress, regardless of counterparties. In addition, the text under this Principle has also used the term shift in NPF, which also means the same thing.
202.
Principle 3.11 - ……“Stress testing should assess future credit exposures and changes in capital requirements...”
The use of “…future credit exposures…” in the Principle statement is subject to interpretations. If the ultimate message is to assess possible credit losses due to changes in credit quality etc., suggest to reword to “…possible credit losses…”. BNM
No change. A credit exposure is a possible credit loss, so IFSB terminology is logical. The term is consistent with IFSB risk management standard. IFSB has used the term “credit exposures” in many standards. In addition, the term has been explained in the text.
203.
Paragraph 72 - ….“For credit risk, the role of stress testing is to identify the possible changes in economic conditions that could have unfavorable effects on credit exposures…”
Although setting scenarios is part of stress testing process, the statement on “the role of stress testing is to identify the possible changes in economic conditions…” seems to suggest that IIFS should use stress test to predict economic condition, rather than using scenarios (which may be anchored to certain economic condition or crisis) to identify the magnitude of possible losses and impact on earnings and capital. As such, suggest rewording the statement. BNM
No change. The ED does not suggest IIFS using stress testing to predict economic conditions, rather identify possible changes in the economic conditions and then looking how they impact the IIFS, which is quite straight forward in any forward looking assessment of risks.
204.
Paragraph 73 - “In particular, the stress scenarios taking account of
The statement depicts that taking account NPF in stress testing is optional and dependent on whether
Agreed. The word “may” has been changed with “should”. This will be
86
IIFS deems NPF is relevant in determining IIFS’s overall soundness. One of the objectives of stress testing of a credit or financing portfolio is to identify any increase in default (hence new NPF) and losses arising from this default and stressed recovery from defaulted assets. Subsequently, impact of the losses on IIFS’s earnings and capital will then be assessed. Suggest rewording the statement. BNM
consistent with aspects listed for credit risk. The concerns relating to NPF are already being addressed in the credit risk aspects. See Paragraph 84.
205.
non-performing financing (NPF) may be highly relevant in determining the overall soundness of the IIFS, particularly in the case of economic downturns…”
We conjecture the issue as to what things are to be taken in reference to the Benchmark Rates alluded to in the concerned provision is also to be clarified. CBRT
No change. See Paragraph 9 (b) for more detail.
206.
To improve clarity, IFSB should breakdown the three stress test approaches to the three risks in to different paragraphs i.e.
(i) stress testing approaches for highly leveraged counterparties
(ii) Stress testing for “wrong-way risk”; and (iii) Stress testing for country risk element.
Suggest separating these three main points into three separate paragraphs. BNM
Agreed to last approach. First two approaches are linked to each, therefore, they cannot be disintegrated; rather the last one should be discussed separately as it related to different subject matter. See revised Paragraph.
207.
Paragraph 74 - Enhancing stress testing approaches for highly leveraged counterparties is appropriate when considering vulnerability to specific asset categories or market movements, and when assessing potential wrong-way risk related to Sharī̀ ah-compliant risk mitigating techniques………
We suppose detailed information is to be provided concerning the explanations on the coverage, management and measurement of the country risk as well as the stress scenarios to he applied to this risk.
No change. The IFSB believes that this should be up to the respective IIFS to decide and employ appropriate methodologies to take into account country risk as well the stress scenarios that will be applicable to the
87
CBRT IIFS. This is important in the cases, where an IIFS have its exposures in various jurisdictions. So various aspects needs to be taken into account. The ED mentions that IIFS engaged in international financing may face additional risk, the most important of which is country risk (or sovereign risk), which encompasses the entire spectrum of risks posed by the macroeconomic, political and social environment of a country that may affect the performance of clients and should be well captured. See Paragraph 86 for more detail.
Principle 3.12: IIFS should take into account various positions in the Sharī̀ ah-compliant financial instruments in trading portfolios considering a range of exceptional but plausible market shocks as part of their IIFS-wide stress testing. Dependencies among different markets and sectors, and consequentially increasing correlations, should be factored into stress testing. Stress testing for holders of Sharī̀ ah-compliant securitisation should consider, inter alia, exposure to market risk of the underlying assets, including their exposures to systematic market factors, market liquidity factors, as well as legal risk and relevant contractual arrangements and embedded triggers in Sharī̀ ah-compliant securitisation structures. 208.
Principle 3.12
Market risk exposures for Islamic trading products are the same as conventional. Stress testing on market risk e.g. FX risk, interest rate risk and equity risk are already in place. Thus, the existing stress testing programme could well adopt in Islamic context. We take note in exploring and improve the stress testing for Shari'ah risk during periodical review. AIB
No change. Noted. The ED does not address interest rate risk under market risk.
209.
Principle 3.12
Currently most of the IIFS in the region are not doing this; if the same is regulated, then process
No change. IIFS will be required to do once the guidelines are available from
88
and system development will be required. DIB
their respective supervisory authority.
210.
Principle 3.12
Our stress testing takes account of our trading portfolio positions. KFHK
No change. Noted.
211.
Principle 3.12
Although wide ranging market risk shocks could be considered but management might still be subjective for capital planning. WB
No change. Stress tests should be used as inputs to the process of establishing an IIFS’s risk appetite and setting exposure limits, as well as being a planning tool to determine the effectiveness of new and existing business strategies and their impact on the capital and liquidity planning process (see detail of actions in Paragraph 140).
212.
Principle 3.12
Treasury Credit (Principle 3.12 Notes: 77 and 78)
77. Under the Market Risk component of BNM RWCAF Framework, section D1.4 requires Banking Institutions to calculate the counterparty credit risk charge for over-the-counter (OTC) derivatives, repo-style and other transactions classified in the trading book, in addition to the capital charge for general market risk and specific risk. The calculation of counterparty risk charge is based on the approaches as prescribed in Appendix VIII.
Whilst the simulation of stressed EAD (replacement cost) for OTC derivatives is to be treated
No change. Noted. The lack of historical data is indeed a challenge to the IIFS which needs to be addressed; however, this should not be a reason to exclude suggested factors in the stress testing. See Section 2.2.
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independently in terms of scenario design, we are of the opinion that the risk analytics governing credit parameters such as PD and EAD should be consistent with the loan book exposures.
78. The market risk factors used to simulate stressed market RWAs should be identical to that used for stressed credit EAD for trading book exposures, with the exception of risk horizon being one year or remaining maturity of exposure, whichever is shorter.
Market Risk (Principle 3.12 Notes: 77- 80)
In general, this is a comprehensive paper and includes the embedded market risk factors in Islamic products. However, the difficulty may arise in quantifying stress quantum for legal risk and relevant contractual arrangements and embedded triggers in Shari'ah compliant securitisation structures due to lack of historical data. Under 77 (d), the Market value of Sukuk and Murabahah assets are measured using Impact on Economic Value (IEV). MBM
213.
Principle 3.12
Important parameter for stress testing, however further study is needed to develop a range of exceptional but plausible market shocks. OCBCA
No. change. IIFS are expected to conduct their own studies to develop relevant range of exceptional and plausible market scenarios and related shocks subsequently.
214.
Principle 3.12- Market risk factors
Based on a suggestion raised at one of the working
No change. In the meeting, it was
90
and stress for Shari'ah-complaint securitization
group meetings, a change has been made to the principles by adding "credit exposure of the originator/issuer of a Sukuk issuer". After this change, the title of the principle "market risk factors" is no longer consistent with the substance of the Principle. Therefore, we would suggest changing the title of the principles to securitization risks as it entails both credit and market risk. CBOS
agreed by members segregating the Shari’ah-compliant securitisation aspects into credit risk and market risk instead of discussing the Shari’ah-compliant securitisation in the market risk Principle 3.12 only, as there are credit aspects of Shari’ah-compliant securitisation which should be discussed under credit risk principle. Hence, changing the title will not address the market risk factors, which are significant.
215.
We understand that the main channels from external shocks to Islamic banks are low oil prices, tight global liquidity conditions, decline in asset prices (equity and real estate) and volatility in exchanges and interest rates. Moreover, although mentioned under real estate risk concentration section, market risk factors could include a fall in housing prices along the stock market one already suggested (para.77). In the same vein, volatility in interest rates should be tested. IMF
The volatility is already addressed in the Para. 90, however, its scope is expanded. See revised Para. 90. Whereas fall in housing prices is discussed in Para. 99.
216.
Para.77 - With respect to market risk stress testing, IIFS should test their positions in Sharī̀ ah-compliant financial instruments in trading portfolios along with underlying risk factors and a range of exceptional but plausible market shocks as part of their IIFS-wide stress testing…… Such factors may include prices, volatilities…..
g) Moreover, we think the issues as to how the limits of the position and stop loss limits mentioned in the concerned article shall be determined and how they shall be associated to the stress rest are also to be elaborated upon. CBRT
No change. Various positions limits (whether short, long or net), stop-loss provisions (i.e. a predetermined loss-exposure market limit) and stressed VaR, should be determined by the respective IIFS and then should be taken into account in the stress testing.
91
Principle 3.13: IIFS should perform stress testing on specific portfolios covering, inter alia, consumer credit portfolios (i.e. Murābahah and Ijārah consumer financing), home purchase mortgage financing portfolios (whether by Murābahah, Ijārah or Diminishing Mushārakah contracts), real estate (including investment and financing), commodity Murābahah transactions, and equity investments (i.e. Muḍārabah and Mushārakah investments). Consideration should be given to changes in correlations between risks that the IIFS identifies for a given portfolio. 217.
Principle 3.13
Agreed, stress testing should be performed on specific portfolios basis. AIB
No change. Noted.
218.
Principle 3.13
This has been the practice of Maybank and complied – portfolios mentioned above are included in the stress test. MBM
No change. Noted.
219.
Principle 3.13
Principle 3. 13 has not included Islamic securities such as Sukuk, central bank Islamic certificates, etc. Indeed, those are also part of specific Islamic portfolio which needs to be stress tested. Moreover, such Islamic securities are not only the ones issued by the government or other government bodies but also others issued by private entities such as private companies, Islamic commercial banks etc. BI
No change. Agreed that Principle 3.13 has not included Sukuk portfolio as it only discussed four main portfolios, however, it should be noted that this issue is being discussed in a separate Principle 3.12 in detail. Nevertheless, based on suggestion, the updated Principle 3.12, now also include following wordings… different types of Sukūk (or equivalent Sharī`ah-compliant debt securities), whether issued by public entities (such as government, central bank, etc) or by multilateral entities or by private entities (such as private companies, IIFS, etc should be taken into account in the stress testing. See Paragraph 90 (a) under Principle 3.12.
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220. Principle 3.13 The Credit Portfolio is to be subjected to separate scenarios on basis of products; e.g. those scenarios that bear different features like home loans, commodity Murabahah, etc. may differ (wherein even the fall or rise of house prices in the home loans could be included in analyses). CBRT
No change. As mentioned in the ED that in the case of a home purchase (mortgage) portfolio, a large decrease in house price, high unemployment and a decline in GDP provide a severe scenario. Other portfolios, such as CMT-based financing and equity-related exposures as discussed below, are exposed to different risk drivers; therefore, a different stress scenario should be applied. IIFS should ensure they stress portfolios and business units in order to identify risk concentrations (see Paragraph 61) that may arise. (For example, a credit risk stress across asset classes and portfolios may identify potential concentrations between retail and corporate exposures.) IIFS should perform stress tests taking into account changes in correlations between risks in various portfolios and recognising interactions between risk types, such as market and credit risk, particularly in times of stress (see Paragraphs 52 and 92).
221.
Principle 3.13
In our region most of the banks do stress testing on the basis of risks based on conventional banking guidance; if the same is implemented; the IIFS would need to do significant development. DIB
No change. IIFS will be expected to employ and take into account once the specific guidelines on these aspects are available from their respective supervisory authority.
222.
Principle 3.13
Our stress testing conducts analysis of all of our financing, investment and equity portfolios, including concentrations in these portfolios.
No change. Noted.
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KFHK
223.
Principle 3.13
It is agreed that stress testing should cover all specific portfolios including consumer, equity, commodity, real-estate etc. WB
No change. Noted.
224.
Principle 3.13
IIFS need further study to identify the impact on the changes in the correlations between risk identified for a given portfolio. OCBCA
No. change. Noted. IIFS are expected to conduct their own studies to identify the impact on the changes in the correlations between risk identified for a given portfolio.
225.
Paragraph 81/82
The guiding principle stated the requirement of stress test on specific portfolio and outline the portfolio required, however does not prescribed specific criteria on the selection of the portfolio i.e. via concentration test regardless of the form of the assets. BMMB
Agreed. The ED makes mention of concentration as a specific criteria in Paragraph 96, which states…”IIFS should be aware that having concentrated exposures in a specific portfolio such as a consumer credit portfolio, real estate (including investment and financing), CMT-based financing or equity investment (under Muḍārabah and Mushārakah) may have the potential to expose them to the increased risks of investment losses on the one hand, and rising NPF on the other, adding to the vulnerability of the IIFS”. The ED also states that the illustrations of certain portfolios as discussed in the ED based on their vulnerabilities are not exclusive and should be referred to as examples.
94
Therefore, IIFS should specify their own portfolios according to risk profiles and concentrations as highlighted in the ED. The IFSB notes that as the market develops, these examples may be replaced with new ones, or new portfolios may be considered in addition to existing portfolios that would need to be captured in the stress testing. Nevertheless, the word “concentration” is inserted in the paragraph 82, to spot the specific criteria. And it would be read as follows: “….The illustrations of certain portfolios as discussed below based on their vulnerabilities and concentration are not exclusive and should be referred to as examples.”
226.
Paragraph 83 - ...… For IIFS that are active in the retail market, consumer credit portfolios based on Sharī̀ ah-compliant contracts such as Murābahah, Muḍārabah and Mushārakah, Dimishing Mushārakah, Ijārah or IMB should be well captured in their stress testing programmes. Stress testing of consumer credit portfolios may require a more granular approach and entail more demanding data requirements than corporate credit portfolios. ……
Current practices require these to be stress tested at product level rather than contract level. Suggest that the existing practice be maintained. SCS
No change. The ED does not suggest consumer credit portfolio to be at contract level rather it emphasis that consumer credit portfolios (including, among others, credit cards/lines of credit cards, instalments financing, etc) based on Sharī̀ ah-compliant contracts such as Murābahah, Muḍārabah and Mushārakah, Dimishing Mushārakah, Ijārah or IMB should be well captured in their stress testing programmes.
227.
Paragraph 84 – The following aspects, inter alia, should be borne
The paragraph describes the aspects in designing stress test programme for credit portfolios. The
No change. The paragraph only
95
effect among each factor should be looked as well, i.e. the correlation and diversification of each aspect in designing stress testing. BRM
describes the aspects in designing stress test programme for consumer credit portfolios not general credit portfolio. However, correlation and diversification of each aspect in designing stress testing is expected to be considered by the IIFS.
228.
a) We feel the matter on the determination of the coverage of the idiosyncratic and systematic factors is to be detailed, too. CBRT
No change. Each IIFS is expected to take into account various factors within the idiosyncratic and systematic factors; it is outside the scope of the ED to detail out each and every risk factor for IIFS. An IIFS should review the nature of its basic activities and the external environment in which it operates in order to identify the list of key risk variables/factors (including individual variables or combinations of variables) that must be tested under different scenarios in the stress testing. The main areas in which an IIFS has considerable exposure (i.e. exposure to various types of on- and off-balance sheet risks, which indicate its vulnerabilities to different shocks) should be those most thoroughly captured under a stress testing programme. See Principle 3.6 for more detail.
229.
in mind by IIFS in designing their stress testing programmes for credit portfolios:
a. both idiosyncratic (borrower-specific) and systemic (economic) factors;
b. various concentration dimensions to be assessed, including industry sector, geographic spread, credit rating, customer segment, and exposure to single counterparties or groups of related counterparties;
……………………………..
Name concentration risk is not critical in consumer credit. Suggest revisiting the relevance of concentration by single counterparties in stress testing a consumer credit portfolio.
No change. Concentration risk can also be apparent in the consumer portfolio just like corporate portfolio. Here, the consideration to concentration risk has been given
96
BNM keeping in mind the practice of several IIFS in certain jurisdictions and the impact study conducted as in those jurisdictions, these factors can play significant role.
230.
To include the possible risk of delay in disposal of the underlying real estate (both in the case of investment and as collateral) as a risk event under stress test. Significant delay in disposal could potentially increase the amount of loss. BNM
Agreed. The suggestion has been added in the Paragraph 99 (i).
231.
Paragraph 85 - ….Real estate risk concentrations are common among IIFS, and such exposures may also be subject to geographic concentration. Such concentrated exposures in real estate can expose IIFS to the various prudential risks that need to be addressed in stress testing, especially as Sharī̀ ah-compliant hedging may not be available, and risk transfer via Sharī̀ ah-compliant securitisation may be difficult to achieve. ……. A stress scenario should factor in the following aspects in real estate related stress testing…
b and j) Furthermore, we share the view that the guidelines are to be stated in reference to the differentiation of those stress scenarios in case of the separation of the credit allocations in the real estate risk in form of investment or financing. Are the focusing on these two allocation types and the risk levels thereof to be assessed in different manners? CBRT
No change. IIFS should refer to IFSB-7 and related IFSB publications on the matter of the capital adequacy implications for real estate exposures from investment and from financing.
232.
Paragraph 86 - To avoid excessive sectoral exposure risk, IIFS should institute appropriate and effective controls including stress testing to determine whether the overall exposure to real estate is consistent with the IIFS’s business strategy and within the tolerance level defined by the internal policies as approved by the BOD. While the range of possible scenarios being considered by IIFS for the
We opine that detailed information is to be given concerning the qualities of the reasonable scenarios implied by the term "plausible scenarios" concerning the paragraph above. CBRT
No change. While the range of possible scenarios being considered by IIFS for the exposures in real estate will vary from micro to macro perspectives, an IIFS should consider plausible scenarios taking into account the aspects listed in Paragraph 99 for the real estate sector and continuously assess any potential adverse implications of prevailing market conditions for the
97
exposures in real estate will vary from micro to macro perspectives, an IIFS should consider plausible scenarios taking into account the above-mentioned aspects for the real estate sector and continuously assess any potential adverse implications of prevailing market conditions for the exposures. …
exposures. An IIFS may relate its range of scenarios with respect to real estate to “sensitivity tests” as discussed in Section 3.4.1. For the scenarios development and execution, IIFS should be guided through Principle 3.7.
Principle 3.14: An IIFS should assess a broad range of liquidity risk factors and various unique perspectives in its stress testing techniques with the aim of enabling it to evaluate its ability (i) to meet its financial obligation at any time arising from funding and assets/market liquidity exposure, and (ii) to identify sources of potential liquidity strain, ensuring that current exposures remain in accordance with the IIFS’s established liquidity risk tolerance. As part of liquidity risk stress testing, an IIFS should aim to take account of simultaneous pressures in funding and asset markets, and the impact of a reduction in market liquidity on exposure valuation. An IIFS should also identify appropriate areas in which the results of liquidity stress tests will be used. 233.
Principle 3.14
We are agreeable to the Principle. AIB
No change. Noted.
234.
Principle 3.14
The Bank is generally agreeable to the Principle above. MBM
No change. Noted.
235.
Paragraph 95 - IIFS should note that funding and asset markets may be strongly interrelated, particularly during periods of stress. As part of an overall stress testing programme, an IIFS should aim to take account of simultaneous pressures in funding and asset markets, and the impact of a reduction in market liquidity on exposure valuation. …….In this
Based on the guiding principle as part of liquidity risk stress testing, an IIFS should aim to take account of simultaneous pressures in funding and asset markets, and the impact of a reduction in market liquidity on exposure valuation. However this is more probable if there is a systemic condition when the liquidity in the market dried out and the Bank shall take into account the impact of the liquidation of assets. The other measure that may be relevant for liquidity stress test is to capture the survival time horizon due to the funding and assets
Agreed with the suggestion. It is added in the Paragraph 109.
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liquidity. BMMB
236.
perspective, IIFS should enhance their stress testing practices by considering important interrelations between various factors…….
Liquidity stress testing analyzes both funding liquidity and market liquidity risks. The note could add an assumption of an increase in haircuts for repo collateral as a way to test for market liquidity. IMF
Agreed. This is now addressed in the Paragraph 109 (vi).
237.
Principle 3.14
We agree this principle. KFHK
No change. Noted.
238.
Principle 3.14
Currently most of the IIFS in our region need time and system support to do scenario based stress testing. DIB
No change. Noted.
239.
Principle 3.14
Stress testing for liquidity & funding is although very important but also sometimes vague. Deposit withdrawals, interbank money market freeze, market mistrust, squeezed credit availability etc are possible shocks but it might not be sometimes cost effective by keeping many liquid / marketable or cash equivalent reserves. WB
No change. Noted. See detail of liquidity factors in the Principle 3.14.
Principle 3.15: An IIFS should include in its stress testing programme various aspects pertaining to Sharī`ah non-compliance risk leading to legal and related reputational risk. An IIFS should be able to quantify the potential impact of Sharī̀ ah non-compliance risk in its stress testing programme under defined scenarios, and ensure that appropriate contingency plans or remedies are in place to effectively manage the Sharī̀ ah non-compliance risk and potential systemic implications for the IFSI. 240.
Principle 3.15
We acknowledge the challenging task to quantify
No change. Noted.
99
the potential impact of Shari'ah non-compliance risk and are exploring how best to approach Shari'ah non compliance risk. AIB
241.
Principle 3.15
It would be a challenging task for the bank to quantify the potential impact of Shari`ah non-compliance risk that may lead to legal and related reputational risk in the stress testing. A major event of Shari`ah non-compliance could happen when a National Shariah Coucil or other authorized bodies issued a Fatwa on certain products or structures which are already being used by the bank that are no longer in accordance with shariah principle. This may impact severity of the bank’s income as large provision has to be put aside due to shariah non-compliance. However, under the normal circumstances, the Shari`ah non-compliance is related to operational risk when the bank fails to execute the procedure according to shariah principle e.g. contract/ document executed not complying with Shari`ah rules and principles and /or breach of contract involving Shari`ah violations. This may have no major impact on the bank’s income as compared to the major event as mentioned above. MBM
No change. The IFSB understands the difficulty of quantifying this risk; however, the importance of quantifying this risk has increased in recent times as noted in the ED. See responses in (248), (250), and (253) below for detail.
242.
Principle 3.15
It is necessary that legal and credibility risks are measured and included in the scenario analyses. Concerning the Credibility Risk, Shari’ah non-compliance risk is to be defined and measured.
No change. This is already being addressed in the revised Principle 3.15.
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CBRT 243.
Principle 3.15
Reputational loss in case of Sharia non-compliance may not be undone in case of any product or service being declared by the relevant authoritative body as Sharia repugnant. We understand that the principle needs further explanations to be included in respect of strict Sharia audit regime as well as the strict parameters to be following in respect of stress testing. DIB
No change. This is already being addressed in the revised Principle 3.15.
244.
Principle 3.15
We consider Shari’ah non-compliance within our stress testing framework as a form of reputation risk that results from failure in our core financing, investment, funding and other operational activities. We have yet to develop a basis for modeling the implications of non-compliance with Shari’ah for default, funding, profitability or balance sheet use. KFHK
No change. Noted.
245.
Principle 3.15
It is agreed that banks stress testing program should also encompass legal, reputational and compliance risks. WB
No change. Noted.
246.
Principle 3.15
Currently as per the CBK guidelines this referred principles are considered under the ICAAP process and not under stress testing. It may be difficult to quantify these principals in stress testing and will have to be largely assumptive based on historical trends or certain possible scenarios. KIB
No change. As noted elsewhere that the IFSB understands the difficulty of quantifying this risk; however, the importance of quantifying this risk has increased in recent times as noted in the ED. Therefore, in this regard, IIFS are guided through number of aspects
101
listed under Paragraph 114.
247.
Principle 3.15
In respect of Principle 3.15, qualitative risk factors such as Shari'ah non-compliance risk, reputational risk and legislative risk would be operationally challenging to collate and quantify. Most financial institutions may not have sufficient/data to form any conclusive assumptions on these risks for incorporation into the stress test programme. Hence, if these risks are to be incorporated under the stress test programme, financial institutions may need lead time to build their data based and develop methodology to quantify these risks. ALIB
No change. Agreed with the comment. Certainly IIFS would need time to build database and develop methodology to quantify these risks and it is hoped that IIFS will be given adequate time to reflect this. However, how much time is given to the IIFS by supervisory authorities will depend on discretion of respective supervisory authorities.
248.
Paragraph 98 - An IIFS should be aware of precedents in certain jurisdictions involving certain Sharī`ah-compliant contracts, where Sharī`ah non-compliance has led to legal and related reputational risk. …Regarding potential Sharī`ah non-compliance, an IIFS should identify and quantify the following: (i) how Sharī`ah non-compliance or the non-compliance of a particular contract might impact the IIFS in terms of (inter alia) funding and financing risk, income and profitability, withdrawal risk, and legal and related reputational risk; and (ii) the magnitude of the cost to the IIFS both directly and indirectly.
The Exposure-Draft requires that stress-testing to be done for "Shari’ah Non-Compliance". The calculation of this aspect will be very challenging. Besides, this is unlikely to happen as transactions are usually scrutinized by the SSB prior to their release. Even if such individual incident takes place, it will be considered as part of idiosyncratic event. In the same way, other risks (such as reputation, legal, BCP, system failure) should be considered. ITB
No change. This is already being addressed in the Principle 3.15 in detail. This Principle does not discuss whole operational risk aspects rather it gives particular attention to Sharī̀ ah non-compliance aspects, however, IIFS can consider similar other events such as BCP and system failure. In addition, it should be noted that though the transactions are scrutinized by the SSB , however, as noted by the ED in Paragraph 112 that there are certain precedents in certain jurisdictions involving certain Sharī̀ ah-compliant contracts, where Sharī̀ ah non-compliance has led to legal and related reputational risk, therefore, it is conceivable that an IIFS may at some point have its
102
adherence to Sharī`ah placed in question, an event which could inflict severe reputational damage leading to loss of business and a potential liquidity crisis (see Paragraph 111). Further, a failure in Sharī`ah compliance could invalidate a contract with costly consequences (i.e. high rewinding cost). Regarding the quantification, the ED does mention the challenging task of quantifying the potential impact of Sharī`ah non-compliance risk leading to legal and related reputational risk by the IIFS, however, in this regard, IIFS are guided through number of aspects listed under paragraph 100.
249.
Shari’ah non-compliance risk is one of the most important factors relevant for stress testing of IIFS and this is covered in Principle 3.15. One way to quantify the Shari’ah non-compliance risk is to have periodic Shari’ah audit of the processes and operations of IIFS and include the results obtained from these audits as part of the stress testing process. Periodic Shari’ah audits will allow management of the IIFS to monitor the Shari’ah non-compliance risk and accordingly add the correct weight of this risk in the overall stress testing process. Another factor for IIFS to consider is the number of counterparties where it has signed up the risk management products and liquidity management
No change. Having periodic Shari’ah audit of the processes and operations of IIFS is risk mitigation or prevention process as a part of Shari’ah Governance framework rather than a mean to quantify the Shari’ah non-compliance impact. There are several aspects which are listed in the revised Draft which can be considered by the IIFS to quantify the financial and reputation impact of Shari’ah non-compliance. Further, Shari’ah non-compliance can be quantified through a proper reference to relevant past events where such information is available. While on the second
103
products. This is important on two fronts: (i) a higher number of counterparties (a) will help the IIFS to reduce its concentration risk; (b) will allow the IIFS to tap a wider market in a distress situation; (c) will enhance access to new and more innovative risk/liquidity management products offered by these counterparties. (ii) having more counterparties also means that the IIFS’s Shari’ah committee has approved a broad range of products offered by these counterparties hence the internal Shari’ah views of IIFS are in line with the wider Shari’ah views of the Islamic finance industry. HKAB
suggestion, it is already addressed in the Principle 3.11 and more importantly the IFSB refrains from giving any endorsement to certain products as the Sharī`ah compliance of certain structures is a matter of controversy and therefore it is left to IIFS’ SSB.
250.
The guiding principle required the IIFS to conduct stress test and quantify the potential impact of Shari`ah non-compliance risk in its stress testing programme. Based on the current framework there is a zero-tolerance to Shari’ah non-compliance and the assessment is focused on qualitative approach except for the capturing of incident management database (IMDC) or loss event database, which is more quantitative. The IMDC approach for stress test is applicable to operational risk stress test unless there is a need and way to delineate between these two. BMMB
No change. In fact Sharī̀ ah non-compliance risk is part of the operational risk as discussed in the IFSB-1 and accordingly the reference to IFSB-1 and its implementation is made as a necessary condition under Section 2 so that this ED does not have to reproduce what has been discussed in the IFSB-1. One of the important consideration by the IIFS should be whether operational risk stress test consider Sharī̀ ah non-compliance risk or not. If IMDC approach for stress test takes into account the incidents related to Sharī̀ ah non-compliance risk then it should be fine, however, if it does not consider then IIFS has to find a way to address this. In regard to the assessment of Sharī̀ ah non-
104
compliance risk, it would require both techniques (i.e. qualitative and quantitative). Regarding the quantification, the ED does recognises the challenging task of quantifying the potential impact of Sharī̀ ah non-compliance risk leading to legal and related reputational risk by the IIFS, however, in this regard, IIFS are guided through number of aspects listed under Paragraph 114.
251.
Paragraph 99 - The following potential risk factors pertaining to Sharī̀ ah non-compliance risk leading to legal and related reputational risk should be included in an IIFS’s stress testing, with particular reference to failures in Sharī̀ ah compliance that could severely damage the reputation of an IIFS…….
List of failures in respect of Sharia compliance is not exhaustive. Certain operations level failures including but not limited to the following: (a) wrong implementation; (b) failure to execute the documents in right chronological order; and (c) execution of certain documents beforehand where such documents should not have been executed and only the forms are agreed. DIB
No change. These aspects have been discussed in the ED already and see revised Paragraphs 113 and 114 for more detail.
252.
Paragraph 100 - It would be a challenging task for an IIFS to quantify the potential impact of Sharī̀ ah non-compliance risk leading to legal and related reputational risk in the stress testing. …………..Further, to mitigate reputational spillover effects and maintain market confidence, an IIFS should develop methodologies to measure the effect of reputational risk on other risk types, with a particular focus on credit, liquidity and market
There is an additional emphasis on 'reputational risk' emanating from non-compliance with Shari’ah principles. This provides an additional scenario to consider centred on reputational risk and its impact on the financial institution. However, reputation risk is one of the most difficult risks in terms of its quantification for which banks may require specific guidance. We recognize that Islamic products introduce additional risks such as Shari’ah non-compliance risk and we will endeavour to incorporate these in our stress testing methodologies. SAMA
No change. Noted. Though, reputation risk is one of the most difficult risks in terms of its quantification, however, IIFS are guided through number of aspects listed under Paragraph 114. To mitigate reputational spillover effects and maintain market confidence, an IIFS should develop their own methodologies to measure the effect of reputational risk on other risk types, with a particular focus on credit, liquidity and market risks.
105
253.
risk………. As IFSB has acknowledged in Paragraph 100 of Section 3.3.7 - Sharī̀ ah non-compliance risk leading to legal and related reputational risk, it is challenging to try to quantify the potential impact of Sharī̀ ah non-compliance. Quantifying the potential loss is not feasible especially in assessing the magnitude of court proceedings and the most difficult or almost impossible to predict is the direct impact on reputational spillover effects. This is very volatile and non-predictive, even if a methodology is developed, it may create unusable non-predictive quantifies impact. It is more logical to focus on internal controls for Sharī`ah non-compliance risk rather than quantifying the potential impact that has too many flaws to begin with. KFHM
No change. The IFSB understands the difficulty of quantifying this risk; however, the importance of quantifying this risk has increased in recent times as noted in the Paragraph 112 and footnote 54. For example, if an IIFS were dependent on CMT for deposits and these transactions were subsequently to be considered non-permissible, what would be the resulting liquidity stress, and how would it be managed? If credits based on CMT were subsequently to be considered non-permissible, what credit risks might result? It will be clear that an IIFS’s SSB needs to be involved in stress testing for such contingencies. Principle 3.15 provides guidance on the potential risk factors (qualitative and quantitative) pertaining to Sharī̀ ah non-compliance risk (which is one of the qualitative risk factors), leading to legal and related reputational risk that should be included in an IIFS’s stress testing as failures in Sharī̀ ah compliance could severely damage the reputation of an IIFS.
254.
It will be a challenge for IIFS to quantify the potential impact of Shari`ah non-compliance risk in its stress testing program under the defined
No change. Noted. See response in (253) above.
106
scenarios. Important risks to consider for IIFS but a challenge in quantifying the stress factors. Further study needed for this qualitative factor to be measured in stress testing. OCBCA
255.
This draft has not mentioned the essential stress testing report for the Sharia Supervisory Board (SSB) of IIFS especially the one in the principle 3.15. The output of such stress testing is very important to be reported and known by SSB as it relates to reputation risk and other risks related to sharia jurisdiction issues. BI
Agreed. The paragraph has been updated to include the suggestion.
256.
Paragraph 101 - As mentioned earlier in Principle 3.3, management should involve the SSB while conducting Sharī̀ ah non-compliance-related stress testing. …. an IIFS should enhance its Sharī̀ ah governance framework dealing with the interaction of its operations (i.e. ensuring that the SSB is adequately briefed about the products, and that there is continuous flow of communication within the IIFS with the SSB having the necessary interactions with other relevant departments).
Involvement of Sharia Board mentioned in paragraph 101 is vague. It should clearly provide that parameters of any such stress testing in respect of Sharia non-compliance risk must be with the approval of the Sharia Board. DIB
Agreed. See revised Paragraph 115 for more detail.
Principle 3.16: The stress testing programme should capture off-balance sheet exposures that may have the potential to damage the reputation of the IIFS. 257.
Principle 3.16
We are agreeable to the Principle. AIB
No change. Noted.
258.
Principle 3.16
This would be considered in the stress test if the risk is material to our portfolio. MBM
No change. Noted.
107
259.
Principle 3.16
The Stress Tests to be inclusive of scenario analyses concerning such regular account items as are likely to work impacts on the credibility or the financial position of the Bank. CBRT
No change. This has been taken into account and Principle 3.17 recommends “scenario analyses” as one of the stress testing methodology.
260.
Principle 3.16
We agree this principle. KFHK
No change. Noted.
261.
Principle 3.16
It is also agreed that stress testing should invariably cover off balance sheet exposures. WB
No change. Noted.
262.
Principle 3.16
Stress Testing covers the off-balance sheet exposures that may have the potential to damage the reputation of the IIFS. Does the principle want to address all off-balance sheet exposures or restricted investment accounts (RIAH) only? We thought the reputation issue is commonly associated with restricted investment accounts. PIDM
No change. The sources of reputation risk can vary from IIFS to another IIFS. The Principle 3.16 has generally recommended all the exposures which are off-balance sheet. However, the nature of the exposures would vary from IIFS to IIFS. See updated Principle 3.16 which has removed the reference to Restricted IAHs and ICIS.
Principle 3.17: IIFS should develop and employ comprehensive stress testing methodologies including, at least, (i) sensitivity analyses (univariate) and (ii) scenario analyses (multivariate) addressing all material risks at various levels, business areas and specific portfolios of the IIFS. 263.
Principle 3.17
We are agreeable to the Principle. AIB
No change. Noted.
108
264. Principle 3.17 This has been the practice of Maybank and complied. MBM
No change. Noted.
265.
Principle 3.17
In addition to sensitivity analysis and scenario testing, the main requirement should include the review and update of testing changing dependencies and correlations assumed between assumption and parameters. We suggest for IIFS to include this as part of the minimum requirement under Principle 3.17. PIDM
Agreed. This is reflected in the Principle 3.17 now under the Paragraph 125 where the distinction between sensitivity and scenario analysis is mentioned.
266.
Principle 3.17
We deploy stress testing methodologies that reflect the complexity of our business, the availability and reliability of data and modelling expertise. We conduct multivariate economic analysis using Vector Autoregressions as well as parametric VaR estimators for market risk and Monte Carlo simulation for operational risk. KFHK
No change. Noted.
267.
Principle 3.17
As suggested, stress testing program should cover all methodologies to test its asset quality including one-variable sensitivity or multi variable scenario based analysis. WB
No change. Noted.
268.
Principle 3.17
The current CBK guidelines mentions methodology based on scenario approach. It may not be required to stipulate that Banks have to necessarily use both sensitivity and scenario.
No change. The ED does not intend to prescribe any particular methodologies, however, the ED has highlighted that in general, an
109
KIB
effective stress testing programme should consist of both sensitivity analyses (univariate) and scenario analyses (multivariate), though the level of detail, will depend on the size and complexity of the specific IIFS. Further, it should also be noted that the applicability and choice of using these methodologies will also depend on the discretion of respective supervisory authority. See response in below (273).
269.
Principle 3.17
Stress test methodologies need to be comprehensive to be useful. More complex modeling like the multivariate scenario analyses without doubt will be efficacious in determining possible risk outcomes over a wide spectrum of possible end results. However such methodology can be moot without ample historical data to input the various variables into the model for calculation. This will present newer banks with a shorter history of operation a huge challenge on coming out with a working model to the satisfaction of IFSB per this paper within the timeline stipulated. ARBM
No change. Noted. The IIFS will have to address both the data and working model before considering this approach. IIFS who don’t have data, they will have to start collecting data at the first stage and meanwhile they can use some internal or external proxies, see Section 2.2 and 2.4 for more detail.
270.
Stress testing guidelines should further define the applicability of different methodologies and what benefits banks will have in adopting certain techniques if it intends to go for advanced approaches. These guidelines should further identify the action plan which imparts the
No change. Applicability of certain methodologies is left to the IIFS as the risk profile of one IIFS will vary from another IIFS. Certainly the most sophisticated IIFS would be expected to run complex models which would be complemented by appropriate
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progression where the bank is heading towards.
BBP
qualitative oversight and supported by combination of approaches (i.e. sensitivity analyses and scenario analyses); therefore, these methodologies can provide them better insight into their risk profiles.
271.
Principle 3.17 - Stress testing methodologies
We would suggest the STWG should provide practical scenarios as examples to IIFS to enable understanding stress testing techniques perfectly. The guiding principles should illustrate some examples on potential shocks and risks impact on the macroeconomic variables. CBOS
No change. The process of developing and executing relevant scenarios is the job of the IIFS. They should themselves identify what scenarios are relevant to them taking into account various risk factors in which they are exposed or likely to be exposed. The IFSB understands the significance of illustration of some examples however; it should be kept in mind that these illustrations might appear misleading given that the scenarios and impacts would vary from jurisdiction to another jurisdiction. Therefore, IIFS and guided through number of aspects in the Guiding Principles that they can undertake while applying stress testing.
The IFSB also understands as noted in various places elsewhere that providing illustration or technical guidance on the Guiding Principles is one of the issues which the IFSB may consider addressing in detail through implementation guidance in future.
111
See responses in (9) and (10) above.
272.
Scenario analysis and sensitivity tests are most frequently used techniques because they are prescribed by the BCBS in its concept paper on stress testing leading up to the issuance of its guidelines in September 2010. For the sake of global standardization, they should continually be used across all jurisdictions and IIFS. IDB has issued clear guidelines on stress testing prescribing the use of the Scenario Analysis and Sensitivity Testing. This has been included in the Market Risk Management Policy of the Bank. It complements the BCBS Stress Testing Guidelines. Wan
No change. Noted.
273.
SAMA Draft Rules on Stress Testing gives a choice of adopting either of the two methodologies (sensitivity or scenario). This principle, however, seems to suggest to undertake both sensitivity and scenario stress analysis which may pose a challenge for banks in terms of defining appropriate multivariate methodologies for which they may require quantitative based guidelines from the supervisor. SAMA
No change. Given that there are various methodologies, the ED does not intend to prescribe any particular methodologies, however, the ED has highlighted that in general, an effective stress testing programme should consist of both sensitivity analyses (univariate) and scenario analyses (multivariate), though the level of detail, will depend on the size and complexity of the specific IIFS. In this regard, though the ED does not provide choice of adopting either of the two methodologies, however, it does states that a less sophisticated or a smaller IIFS may place greater emphasis on the qualitative elements of its stress testing programme and hence may use sensitivity analyses to
112
form a first approximation of the impact, whereas a large, sophisticated IIFS would be expected to run complex models which would be complemented by appropriate qualitative oversight and supported by combination of approaches (i.e. sensitivity analyses and scenario analyses).
It is reasonably expected that IIFS will benefit from specific guidance and periodic reviews provided by their industry supervisory authorities in establishing and maintaining an effective stress testing framework (including quantitative based guidelines).
274.
Paragraph 103 - …….. The combination of approaches, as well as the level of detail, will depend on the size and complexity of the specific IIFS. A smaller IIFS may place greater emphasis on the qualitative elements of its stress testing programme supported by quantitative outputs of the balance sheet, whereas a large, sophisticated IIFS would be expected to run complex models which would be complemented by appropriate qualitative oversight.
This stipulation allows smaller IIFSs to rely a lot more on qualitative approaches to quantitative ones in their stress testing, and that lesser detail in the testing may be acceptable. More clarity and guidance on this would be useful, so that respective IIFS who adopts more qualitative elements in their stress test methodology may not inadvertently not meet the spirit behind this particular guiding principle. ARBM
No change. See response in (77) above. Also see responses in (9) and (10) above with respect to additional guidance on stress testing.
275.
Paragraph 104 - Sensitivity analysis (univariate tests) measures the change in the value
The sensitivity analysis could also include a migration of loans to a weaker classification.
Agreed with suggestion. This is reflected in the revised Para. 119.
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of a portfolio resulting from shocks of various degrees due to different risk factors … (e.g. a straightforward shift in probabilities of defaults (PDs), or the default of an IIFS’s largest counterparties, or a decline in value of assets).
IMF
276.
Footnote 49 - The IFSB recognises that there are other stress testing methodologies such as Simulation (using Monte Carlo), Maximum Loss Approach and Extreme Value Theory, which have emerged in recent years, but these approaches have been confined to a limited number of IIFS, owing to their complexities, sophistication and limited usage in the conventional sector (see also Section 1.3(b)).
Footnote 49 states: “The IFSB recognises that there are other stress testing methodologies such as Simulation using Monte Carlo), Maximum Loss Approach and Extreme Value Theory, which have emerged in recent years, but these approaches have been confined to a limited number of IIFS, owing to their complexities, sophistication and limited usage in the conventional sector” The basis of this view (“confined to a limited number of IIFS”) has not been provided and may be challenged as follows:- (a) In the process of developing a draft stress testing framework for IDB in early 2009, it was observed that the Asian Development Bank implemented an income-based stress testing methodology that measures the bank's capacity to absorb income losses caused by credit shocks, and at the same time to generate enough income to sustain post-shock loan growth rates. This is not very complex and uses internal and external risk ratings of borrowers and potential portfolio scenarios generated with Monte Carlo Simulation technique. Moreover, according to IMF, types of stress test include Extreme Value, Maximum Loss and Monte Carlo methods (see IMF working paper, 2001, “Stress Testing of Financial Systems: An Overview of Issues, Methodologies, and FSAP
No change. Given the varying risk management cultures among IIFS, the models and methodology developed and employed by IIFS may differ among IIFS and therefore, the ED does not intend to prescribe any particular methodologies, however, the ED has highlighted that in general, an effective stress testing programme should consist of both sensitivity analyses (univariate) and scenario analyses (multivariate) consistent with BCBS (2009) and CEBS (2010) guideline on stress testing. The recommendations of these two main methodologies are also consistent with the findings of the Survey conducted by the STWG. It should be noted that the Guiding Principles provide some examples of current practices that can be considered as best practices; with due recognition that these practices will and should change as markets change and as technology, financial engineering and improved coordination between supervisory
114
Experiences). (b) Limited use of Monte Carlo Simulation, Maximum Loss Approach and Extreme Value Theory techniques by IIFS should not preclude the working group from developing and including guidance on these methodologies as utilization may grow in the future warranting revision to the standard. IDB
authorities make other strategies available. It is not the intent of the Guiding Principles to prescribe every possible control procedure. Instead, the IFSB will review and revise these recommendations from time to time (see paragraph 14).
Principle 3.18: IIFS should develop reverse stress tests as one of their risk management tools to complement the range of stress tests they undertake. 277.
Principle 3.18
We are agreeable to the Principle. AIB
No change. Noted.
278.
Principle 3.18
The Bank will endeavour to attempt reverse stress testing in future Group Stress Tests. MBM
No change. Noted.
279.
Principle 3.18
Principle 3.18: Does reverse stress tests mean back-testing?
Wan
No change. Reverse stress testing is seen as one of the risk management tools usefully complementing the “usual” stress testing, which examines outcomes of predetermined scenarios. Reverse stress testing starts from a known stress test outcome (such as breaching regulatory capital ratios, or a liquidity crisis) and then asking what events could lead to such an outcome for the IIFS (see Principle 3.18).
115
280.
Principle 3.18
Rather than prescribing that ‘IIFS should develop reverse stress tests’, language used in the BCBS document may be used instead: IIFS should determine what scenarios could challenge the viability of the banks and thereby uncover hidden risks and interactions among risks. We recommend for the alternative text to be adopted. PIDM
No change in the Principle as the wording used in the Principle is consistent with CEBS, which is more comprehensive than BCBS; however, suggested wordings can be incorporated in the main text. See updated text under Principle 3.18. In addition, discussion on usefulness of reverse stress testing is also expanded based on CEBS.
281.
Paragraph 111 - …. A reverse stress test induces an IIFS to consider scenarios beyond its normal business settings and leads to events with contagion and systemic implications. Reverse stress testing has important quantitative and qualitative uses, such as informing senior management about the assessment of vulnerabilities. …..
More guidance and detail on reverse stress test would be beneficial, as one may argue it is merely an extension of a standard stress test exercise, to make it more broad and all-encompassing. A reverse stress test we take it is mainly qualitative and that involves brainstorming of possibilities rather than quantitatively derived. ARBM
Agreed. More guidance and detail on reverse stress test is provided in the Principle 3.18. See updated Paragraphs 126-128.
282.
Principle 3.18
Reverse Stress Tests are to be applied That means to say, a scenario that was realized on any date is to be analysed in reference to the past and thus it is to be determined that as result of which indicators the scenario came true. CBRT
No change. IIFS should determine what scenarios could challenge their viability and thereby uncover hidden risks and interactions among risks (i.e. developing reverse stress testing). Reverse stress testing starts from a known stress test outcome (such as breaching regulatory capital ratios, or a liquidity crisis) and then asking what events could lead to such an outcome for the IIFS. As such, reverse stress
116
testing complements in an important way the existing stress testing framework. It requires an IIFS to assess scenarios and circumstances that would put its survival in jeopardy, thereby identifying potential IIFS-wide business vulnerabilities. See more detail in the revised Principle 3.18.
283.
Principle 3.18
We recognize the advantages of reverse stress test as a basis for assessing the resilience of the business model. At this stage of implementation we will run selective reverse stress tests where we consider that they add insight into the risk in the relevant business sector or subsidiary. KFHK
No change. Noted.
284.
Principle 3.18
Stress test no doubt should also incorporate back testing as well reverse testing. WB
No change. Noted.
285.
This clause although is very appropriate, may be tough to implement considering subjectivity of opinion on the point of insolvency. More specificity is required. KIB
No change. See more detail in the revised Principle 3.18.
Principle 3.19: An IIFS should review and update its stress testing methodologies, taking into account: (i) changing market conditions; (ii) changes in the nature, size or complexity of the IIFS’s business model and activities; and (iii) actual experiences in stress situations. An IIFS should have a process in place to review the adequacy and reasonableness of its stress test methodology and assumptions. 286.
Principle 3.19
We are agreeable to the Principle. AIB
No change. Noted.
117
287.
Principle 3.19
We agree this principle, the relevance of stress testing as a risk management tool is critically affected by the reliability of the results. We will continue to review and update our stress testing methodologies to ensure that they remain relevant. KFHK
No change. Noted.
288.
Principle 3.19
Stress testing should be dynamic with regular updates based on market conditions. WB
No change. Noted.
289.
Principle 3.19
This has been the practice of Maybank and complied. The Group Stress Testing Framework is reviewed annually to address the above concerns. MBM
No change. Noted.
290.
Principle 3.19 point (i) needs to add “changing of the third parties conditions” such as changing of depositors and business partners conditions. It is attempted to broaden the scope of stress testing especially to capture changing in (for example) the behaviour of depositors and business partners because of liquidity problems, economic conditions, business activities or other risks. BI
Agreed. This has been updated in the Principle 3.19. In addition, The examples in (ii) and (iii) have been added too.
291.
Principle 3.19
To include the following:
• IIFS should review and update stress test scenarios and assumptions (in addition to methodologies as stated)
• Taking into account more recent and relevant data (in addition to the three items
Agreed. This is reflected in the revised Paragraph 130.
118
stated) BNM
Principle 3.20: An IIFS should conduct stress tests on a regular basis, with appropriate intervals at all levels in accordance with the nature of the risks covering its banking portfolios and trading portfolios, IIFS wide and on an ad-hoc basis. 292.
Principle 3.20
Agreed that the frequency of stress testing should be determined in accordance with the nature of the risk. AIB
No change. Noted.
293.
Principle 3.20
This has been the practice of Maybank and complied. Enterprise-wide stress testing is conducted on half-yearly basis, liquidity risks on monthly basis and ad-hoc stress test as-and-when required. MBM
No change. Noted.
294.
Principle 3.20
We agree. We believe stress tests should be conducted on a quarterly basis and plan to operate as such. KFHK
No change. Noted.
295.
Principle 3.20
Stress testing program should be regular, consistent and comprehensive covering all material risks. WB
No change. Noted.
296.
Principle 3.20
Principle 3.20: Please clarify “regular basis” and “appropriate intervals”. Does performing stress tests every quarter is considered appropriate? Does it have to be correlated with the size and complexities
No change. Regular basis (which is opposite of ad-hoc basis) refers to the frequency set for the purpose of stress testing, i.e. how many times
119
of the IIFS?
Wan
stress testing activities should be conducted at the IIFS level, then subsequently deciding the appropriate intervals or frequency for different portfolios depending on the nature of the portfolios and exposures as well as other circumstances. Just to be consistent with the caption, the word “interval” has been changed with “frequency”. Frequency of stress testing should be determined by the IIFS and bearing in mind its risk profile and certainly it should be consistent with size and complexities of the IIFS.
297.
Paragraph 114 - …. In order for stress testing to be a meaningful part of the risk management framework, stress tests should be undertaken with appropriate frequency in the light of the nature of the risks to which the IIFS are exposed and the types of tests performed. With regard to conducting stress testing, IIFS should specify appropriate frequency of the stress tests (i.e. how many times stress testing activities should be conducted at the IIFS level, depending on the nature of the portfolios …as well as other circumstances)………
All IIFS in Malaysia conduct stress tests semi-annually per the Central Bank directive. This should be sufficient in normal times, and increase in frequency would be of benefit when the market or economy gets hairy and crisis looms. However, we would appreciate more info on situations which would require daily stress testing, which may be an onerous requirement. ARBM
No change. Daily stress testing situations will depend on the type of the portfolio that IIFS hold. With respect to specific situation, once could say that any trading portfolio consisting of Sukuk or equities, may require daily stress testing.
120
Principle 3.21: Stress tests should be used to support a range of decisions. IIFS should identify credible management actions that address the outputs of stress tests and are aimed at ensuring their ongoing solvency throughout the stressed scenario. Stress test outputs should permit management to assess the ability of the IIFS to withstand difficult conditions, in terms of measuring the impact particularly on liquidity, capital adequacy and profitability. 298.
Principle 3.21
We are agreeable to the Principle. AIB
No change. Noted.
299.
Principle 3.21
This has been the practice of Maybank and complied. Impact on liquidity, capital adequacy and profitability are assessed. MBM
No change. Noted.
300.
Principle 3.21
We agree to this principle. KFHK
No change. Noted.
Principle 3.22: An IIFS should make available the key information, both qualitative and quantitative, on its stress testing programme for internal and external communication by using an appropriate disclosure methodology within the existing reporting mechanism. 301.
Principle 3.22
Currently, detailed results are disclosed to BOD & regulator (BNM). Agree to the ED-13 recommendation that the appropriate medium, scope and frequency of the external disclosures should be a matter for management discretion and supervisory requirement. AIB
No change. Noted.
302.
Principle 3.22
This has been the practice of Maybank and complied. The end result and general assumptions of the stress testing are generally disclosed to rating agencies.
No change. Noted.
121
MBM
303.
Principle 3.22
Principle 3.22 provides that key information of the stress testing program should be made available for internal and external communication. This principle is anchored on the objective of achieving transparency and promoting market discipline. However, some caution may be necessary so that the gains from transparency are not eroded by any confusion that the released information may generate. We like to share two (2) specific perspectives on this matter: a. Since the stress tests are not, to understanding,
made uniform by the regulatory authority across covered IIFS, the tests are then more defined by the individual institutions. There is some care necessary then for the public to appreciate the raw results since the tests themselves may widely differ from one IIFS to another. Unnecessary confusion may arise if the test results are interpreted incorrectly by the public.
b. There may likewise be some hesitance on the
part of the IIFS to disclose potentially negative information about any shortcomings on a particular stress test. It is possible then that the tests are not as "stressful" as they are intended to be by the regulators. The transparency principle in this particular case is overtaken by potential conflicts of interest within the IIFS as it manages its own communications.
BSNP
No change. The IFSB understands the issue of unnecessary confusion that may arise as a result of stress testing. However, it should be noted that the ED does not call the disclosure beyond the existing international practices such as those BCBS.
Therefore, the recommendations related to stress testing are consistent with BCBS and further the ED recommends that the appropriate medium, as well as the scope and frequency of the external disclosures, should be a matter for management discretion but also for supervisory requirements (see Principle 4.7).
Therefore, IIFS and supervisory authorities have to determine appropriate regimes under which the stress testing-related information could be disclosed, keeping in mind issues of sensitivity, reliability and materiality.
See also responses in (205), (206) and (208) below.
304.
Principle 3.22
We agree to this principle.
No change. Noted.
122
KFHK
305.
Principle 3.22
Current guidelines stipulate reporting internally and to the central bank. Unless standards are set under pillar 3 disclosure for external disclosures of stress testing (other than CBK) the existing guidelines of CBK is more appropriate for disclosures of stress testing results. KIB
No change. See responses in (306), (307) and (308) below.
306.
Principle 3.22
Principle 3.22: Management Committee of the IIFS should decide on appropriate level of communication of stress testing results to internal and external users. Care should be exercised not to divulge market sensitive and proprietary information to the market, business partners, creditors and competitors.
Wan
No change. This is expected to be well taken by the IIFS and their supervisors. The ED also recommends that the appropriate medium, as well as the scope and frequency of the external disclosures, should be a matter for management discretion but also for supervisory requirements (see Principle 4.7).
307.
Principle 3.22 - An IIFS should make available the key information, both qualitative and quantitative, on its stress testing programme for internal and external communication by using an appropriate disclosure methodology within the existing reporting mechanism.
Disclosure of stress testing programme to internal and external parties. Please clarify further the scope of the disclosure as currently as part of risk management disclosure under corporate governance framework, we did include the methodologies and assumptions utilized for the stress test and how we going to assess the impact. If the comprehensive disclosure is required under the stress test, method and standardized template must be provided similar to Pillar 3. BMMB
No change. As the ED highlights that the key information which needs to be disclosed should be subject to respective supervisory requirements (see Principle 4.7). The ED further states that the disclosure methodology should be consistent with IFSB-4, which states that disclosures could be provided either as part of the disclosure requirements associated with periodic financial reporting, or any other appropriate means (e.g. such as via the Internet or via the public portion of regulatory
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reports filed with the supervisor) agreed by the management.
The ED recommends that the appropriate medium, as well as the scope and frequency of the external disclosures, should be a matter for management discretion but also for supervisory requirements (see Principle 4.7). Therefore, IIFS and supervisory authorities have to determine appropriate regimes under which the stress testing-related information could be disclosed, keeping in mind issues of sensitivity, reliability and materiality.
The approach that has been taken in the ED is to refer to the supervisory authority and it is up the supervisory authority to allow what sort of information would be required by the institutions. Not only what should be disclosed by the IIFS but also when to disclose, should be subject to the approval of respective supervisory authority as it has been rightly highlighted in the ED. Some supervisor can require quarterly while others can require annually or semi-annually disclosures, so therefore, it is up to the supervisors to decide such arrangements, and one can expect that these arrangement would vary in terms of what would be disclosed and when it would disclosed.
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308. Principle 3.22 requires that banks must publicly disclose the results of its stress-tests. Once again, we reiterate that in the absence of national standardized parameters, benchmarking becomes an issue and publicly disclosing such information may give wrong signal to shareholders and stakeholders in a way that will severely affect going concern of banks. Furthermore, stress tests are highly bank-specific. More likely than not, many market participants will not be able to make sense out of an exclusive disclosure of stress testing results. This is due to the likely diversity of these results. Hence, banks would be required to give additional explanations. We therefore suggest reviewing this Principle. ITB
No change. See above response (306).
309.
Paragraph 122 - Stress testing plays an important role in the communication of risk within the IIFS (i.e. to inform the BOD) as well as in external communication to the supervisory authorities through periodic reports and public disclosures through the periodic financial reporting process. ….. Information to be disclosed might include any major stress test limitations, underlying assumptions, governance process, appropriate frequency, the methodologies used, and an evaluation of the impact of the stress test (i.e. the impact on the IIFS’s profitability, capital and asset quality, etc.).
To remove the wordings in paragraph 122: Information to be disclosed might include any major stress test limitations, underlying assumptions, governance process, appropriate frequency, the methodologies used, and an evaluation of the impact of the stress test (i.e. the impact on the IIFS’s profitability, capital and asset quality, etc. Rationale: The objective of a stress test is to embed the result in the risk and capital management process. The potential impact of stress is evaluated and becomes a key focus area during capital and business process. The impact analysis is being used as management tool to develop required action plans. Disclosing the potential impact will only create unnecessary panic for the public and is not reflective of the actual financial position. Sharing the information on the stress impact may unnecessarily
No change. There are international standards available such as IFRS-7, Pillar III of Basel II, and IFSB-4, which require institutions to disclose certain information. These disclosures requirements put forward in the ED are in consistent with Basel II requirement under stress testing. For instance, BCBS’s Guiding Principle of Stress 2 suggests “…. This supporting information could include any major stress test limitation, underlying assumptions, the methodologies used and an evaluation of the impact of the stress test”.). It should be noted that this standard is not aiming to go beyond what is already been considered a practice by the international standard setting bodies.
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destabilise the industry, especially to parties who may not understand fully the use of stress test or assumes that the worst case is something which is imminent in the short-term. KFHM
In addition, the ED also makes reference to IFSB-4 which is equivalent to Pillar III suggesting that the disclosure methodology should be consistent with IFSB-4 and appropriate medium, as well as the scope and frequency of the external disclosures, should be a matter for management discretion but also for supervisory requirements (see Principle 4.7). Therefore, IIFS and supervisory authorities have to determine appropriate regimes under which the stress testing-related information could be disclosed, keeping in mind issues of reliability and materiality.
310.
Recommend IFSB to supplement the requirement of Public Disclosures with Practice Notes specifying more detailed standards for IIFS to adopt/implement. HLIB
No change. IFSB-4 addresses this concern and IIFS are recommended to use the format provided in the IFSB-4 as disclosure methodology. The IFSB does not intend to issue separate guidance on this issue. In addition, it should be noted that the scope of disclosures is a matter for management discretion and also for supervisory requirements (see Principle 4.7).
311.
Agree that disclosure relating to stress testing programme must be made within existing reporting mechanism e.g. under Pillar 3, because by itself, the stress test results may be misleading. In addition, the scope of the key information
No change. These suggested additional requirements must be subject to respective IIFS and supervisory authorities. The disclosure requirements put forward in
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communicated to stakeholders should at least cover the nature of risk profiles, potential downside losses, input for capital planning for immediate and medium term, limit setting as well as contingency planning in event stress event occurs. We suggest IFSB to consider including second paragraph of PIDM’s comments as part of the Principle. PIDM
the Paragraph 143 are in consistent with Basel II requirement under stress testing. Therefore, further disclosures should be subject to respective IIFS and supervisory authorities.
SECTION 4: GUIDING PRINCIPLES ON STRESS TESTING FOR SUPERVISORY AUTHORITIES
Principle 4.1: Supervisory authorities should regularly undertake comprehensive assessments of an IIFS’s stress testing programme. They should review stress testing outputs as part of the supervisory review process as per IFSB-5 in order to assess the resilience of an IIFS to adverse economic conditions and whether it is able to maintain sufficient capital and liquidity under stressed conditions. 312.
Principle 4.1
We agree to this principle. KFHK
No change. Noted.
313.
Principle 4.1- Supervisory authorities should regularly undertake comprehensive assessments of an IIFS’s stress testing programme. They should review stress testing outputs as part of the supervisory review process as per IFSB-5 in order to assess the resilience of an IIFS to adverse economic conditions and whether it is able to maintain sufficient capital and liquidity under stressed conditions.
Principle 4.1 only states the obligatory of the supervisory authorities to conduct regular assessment on stress testing program. In fact, besides the regular one, it might also state the possibility of the supervisory authorities to conduct a non regular (ad hoc) assessment on stress testing program in responding to a certain condition or an extreme economic/business condition. It is important as the supervisory authorities need to take necessary decisions under the normal or abnormal economic conditions. BI
Agreed. A new Paragraph 151 has been added in the Principle 4.1 after explaining the regular assessment of stress testing to reflect this suggestion.
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314.
Applicability of specific requirements of stress for Islamic based products and its integration with conventional stress test for hybrid banks require further clarification from respective supervisors. SAMA
No change. Noted. This clarification is addressed in the Section 2.5.
315.
Stress testing is an estimation process intended to assess the ability of the financial institution to withstand and overcome stressful business conditions arising from a multitude of factors. The methodology involves subjective decisions, assumptions, expert judgment, visualising economic and financial sector scenarios that can affect institutions and assumptions on the direction and extent of market movements. The subjectivity in the choice of the parameters and in the modelling of stress test can lead to endless debate with an external appraiser. Given that there can be infinite number of scenario to consider and no definite number of general risk factors, specific risk factors and qualitative risks for an institution, an external independent reviewer can disagree on any aspect of the stress test. In view of the above, there must be definite and clear-cut guidelines on the review process from the regulators to the independent External Firms that engage in the assessment of the stress testing programme of a financial institution. IIB
No change. Noted. This clarification is addressed in the Paragraphs 47 and 55 and therefore the external independent reviewer should take into account the explanation provided in these paragraphs. For instance, the paragraph suggests identifying only the list of key risk variables/factors (including individual variables or combinations of variables) that must be tested under different scenarios in the stress testing. In addition, the paragraph 55 recognises that ……Given that an infinite number of scenarios could be run, the total number needs to be limited, and an IIFS would need to balance maximising the coverage of the scenarios against managing the costs of running the scenarios and filtering results into a form that can be discussed and taken on board by the BOD and translated into action. With respect to definite and clear-cut guidelines/guidance on the stress testing from the regulators to the IIFS is outlined in the Section 2.5 and
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review process is addressed under Section 4 and therefore, as such same guidance is to be followed (or to be complied) by others such as Independent External Firms as reference when making review of the IIFS with respect to stress testing.
316.
The Principle should include the fact that supervisors should also look for evidence that stress testing is integrated into institutions’ internal risk management processes, as well as business and strategic planning process. IFSB may want to incorporate PIDM’s suggestion as part of Principle 4.1. PIDM
No change. See response in (112) above.
Principle 4.2: Supervisory authorities should ensure that they have the capacity and adequate skills to assess an IIFS’s stress testing programme. In particular, they should have in place a process of evaluating the IIFS’s stress testing methodologies. Supervisory authorities should challenge the scope, severity, assumptions and mitigating actions of IIFS-wide stress tests.
317.
Principle 4.2
We agree to this principle. KFHK
No change. Noted.
318.
Paragraph 132 - …The scenarios chosen should also include, where relevant, an episode of financial market turbulence or a shock to market liquidity. In their evaluations, supervisory authorities should review whether the IIFS uses output from sensitivity tests appropriately, and shares
This document should emphasize on the evaluation of inputs of the stress tests that are done. The results of stress test are as good as the inputs used for testing. E.g.:
• Period of data sample taken (normal vs. crisis)
• Sample size • Proxy data (before a big enough sample
Agreed. The suggestion has been reflected in the revised paragraph.
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sensitivity analysis results within the organisation (such as with risk managers and senior management) and properly acts upon the results (e.g. by taking remedial actions if sensitivity tests show large adverse outcomes or reveal model weaknesses).
size is accumulated for a new product) • Simulation of data, and the parameters
used for simulation • Justification for stress numbers/parameters BNM
Principle 4.3: Supervisory authorities should consider the financial soundness of an individual IIFS and aggregation of all IIFS’ estimates and evaluate the impact of economic stress on the banking sector. They should design and implement system-wide supervisory stress test exercises based on common scenarios as a part of their assessment of the overall system’s resilience to shocks, and may also consider recommending specific scenarios to IIFS. Supervisory authorities should also take into account the cross-border and cross-sectoral implications of the Islamic financial services industry (IFSI) in the stress testing programmes. 319.
Principle 4.3
We agree the need for the Central Bank to design and implement a set of system-wide stress tests and specific scenarios. We stress the need for this analysis to be conducted under assumptions that are applied in a consistent way by all Financial Institutions taking account of the evaluation of FI’s stress testing capabilities conducted in accordance with principle 4.2. KFHK
No change. Noted.
320.
Principle 4.3
The draft carefully outlines guidelines for individual banks to undertake stress testing. It also provides some guidelines to supervisory agencies to check the quality of the stress test undertaken by the banks themselves. However, it is not clear from the draft (Principle 4.1 and 4.3) if the current guidelines aim to ultimately follow the standard practice of carrying regularly jointly solvency and liquidity stress testing exercises between banks (BU, bottom-up) and supervisory agencies (TD, top-
No change. The Principle 4.3 does make specific mention of conducting the macro-prudential or aggregate stress testing or system-wide supervisory stress test in the Paragraphs 163-168. Conducting joint exercises is implicit in the guidance presented in the Principle 4.1, Principle 4.3 and Principle 4.5.
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down) with common scenarios as an internal exercise or to feed into a Financial Stability Report. Usually the TD exercise carried out by the supervisory agency using supervisory data is used to cross-checked the results of the BU undertaken by the banks since both use the same scenarios even though the models are different. The note would benefit of a clarification of the underlying strategy. IMF
321.
Principle 4.3
One general benefit for a regulator-defined stress test is the natural consequence of aggregation. Since the same stress parameters are used in the same test, and then the results for all IIFS can be integrated into a system-wide result. While this aggregation is devoid of any correlation effect across IIFS institutions, it is still useful information for the regulator since it can be interpreted as a first round effect of the designed stress parameters. Should the result be disclosed to the public, the aggregated information provides a macro- outlook on the system in the event of stress. The regulators may then consider remedial action on a per institution basis if it chooses not to have the individual IIFS report their own results. BSNP
No change. This is already addressed in the Paragraphs 163-168 of the revised ED.
322.
Paragraph 134 - Supervisory authorities should consider the financial soundness of individual IIFS and aggregate all IIFS’ estimates in order to evaluate the
We request that the findings from the compilation of the stress tests results from the various IIFS and the macro level stress tests conducted by the supervisory authorities (paragraph 129 and 134) should be shared by the supervisors with the IIFS.
No change. The IFSB believes that this issue of sharing results of whole system will depend on the discretion of respective supervisory authority as the parameters considered, factors
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impact of an economic stress on the banking sector. Supervisory authorities should identify and apply various risk factors and aspects while conducting stress testing at the system level. …….”
KFHB
included, and methodology covered in the stress testing exercise might not be relevant to IIFS thus it may not sharing at all to IIFS, however, a supervisory authority may consider making available those results to IIFS through certain appropriate means such as through Financial Stability Report.
323.
Paragraph 135 - …..Macro-financial stress testing should help supervisory authorities to identify systemically important IIFS that are more sensitive to economic stress…
The draft could add that stress testing outcomes could also play a role in designing macro-prudential policies. IMF
Agreed. The Paragraph 164 is updated to reflect this suggestion.
Principle 4.4: Supervisory authorities should review the range of remedial actions envisaged by an IIFS in response to the results of the stress testing programme and should require the IIFS to take corrective actions if material deficiencies in the stress testing programme are identified or if the results of stress tests are not adequately taken into consideration in the decision-making process.
324.
Principle 4.4
We agree this principle. We would welcome the opportunity to discuss any proposed actions before they are implemented to ensure that any lack of clarity or information on our part does not lead to misunderstanding about our stress testing program and management’s response to the results. KFHK
No change. Noted.
325.
Principle 4.4
This Principle gives a connotation that remedial actions are required in response to each and every stress testing programme. Corrective actions on ad-hoc basis after each and every stress test may distort holistic review of the institution’s safety and soundness. Supervisors should be cautious and take a more holistic view of all the remedial actions
Agreed with the suggestion. This has been reflected in Paragraph 172 under the Principle 4.4.
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and their impact on the institutions. IFSB many want to consider including the second paragraph of PIDM’s comments as part of the Principle. PIDM
326.
Principle 4.4
In case there are material deficiencies based on the stress testing results, the principles require that the regulated entity submit a plan of corrective actions subject to further evaluation by the regulator. We would like to suggest however that the regulator can impose specific actions/sanctions should the entity fail to initiate said corrective actions as may be warranted. If the stress test is done under an ICAAP-like program, then the remedial actions are also discussed with the regulatory authority. This may be relevant particularly to institutions considered as systemically important or when deficiencies are deemed chronic and a threat to the system-wide stability. BSNP
No change. This is already addressed in detail in Paragraphs 170-173.
Principle 4.5: Supervisory authorities should regularly engage in a dialogue with IIFS and the industry to identify systemic vulnerabilities in the IFSI. In the case of an IIFS operating cross-border, appropriate discussions should be held between the consolidating and host supervisory authorities to ensure coordination of supervisory activities, including the stress testing activities undertaken at group level, so as to address all the material risks of the IIFS. 327.
We agree to this principle. KFHK
No change. Noted.
328.
Principle 4.5
It is important to recognize that stress testing programs typically assign no probability to the
No change. The stress testing results do not entail closer to zero (0) percent
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outcome of a test. It is sometimes too easy, therefore, to adopt the view that the scenario that generates the results has such a low probability of occurring that no management action is required. To mitigate this risk, we plan extensive dialogue with Senior Management and the Board in advance of running the analysis to form realistic views on the materiality of the stress and the need for management action. The same problem can occur with System-Wide stress tests which can result in outcomes that are considered to be too severe to have any possibility of occurring. We would welcome the opportunity for KFH to participate in industry discussion with the Central Bank on the formulation of stress test scenarios in advance of implementation. KFHK
of the probability of occurrence, if that is the case, then the whole stress testing programme is questionable and will not serve the intended purpose because stress testing programme as a whole should be acted upon and feed into the decision-making process at the various levels. The influence of the stress test should not only be limited to preparation of contingent action plan and to certain extent defining the portfolio mix. See Principle 3.21. Further, the ED mentions that relevant and plausible stress testing scenarios with a forward-looking perspective should be accompanied by an indication of the estimated probability of the event occurring. With respect to industry discussions, it is a prudent practice for supervisory authorities to proactively engage in a dialogue with IIFS operating in their jurisdiction and industry, with the aim of discussing stress testing practices and identifying emerging risks and systemic vulnerabilities. See revised Principle 4.5 for more detail on regular supervisory dialogue with IIFS and Industry.
329.
Principle 4.5
We agree that regular engagement between home and host supervisors is crucial to allow for a coordinated effort in governing the stress testing activities and to provide for a more holistic view of
Agreed on the substance of the suggestion. The suggestion is reflected in the paragraph 178 of Principle 4.6 after the working group
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vulnerabilities for IIFS businesses that operate across borders. Therefore, mutual acceptance by both home and host regulators is required in this area. We suggest adding sharing of home-host information which can be facilitated through formalised platforms, e.g. the supervisory college arrangement, as an institutionalised mechanism for greater cooperation. PIDM
discussion
330.
Principle 4.5
Principle 4.5: Apart from home-host supervisory authorities’ regular dialogue, the supervisory authorities of IIFS should have regular dialogue with IDB-IRTI.
Wan
No change. It is beyond the scope of this ED to recommend that supervisory authorities of IIFS should have regular dialogue with IDB-IRTI. However, sharing of home-host information which can be facilitated through formalised platforms, e.g. the supervisory college arrangement, that has been added in the ED.
331.
Principle 4.5- para.143 on p.50 (In the case of a cross-border-operating IIFS, appropriate discussions should be held between consolidating and host supervisory authorities to ensure coordination of supervisory activities, including the stress testing activities. Home and host supervisory authorities should assess the stress tests performed by a cross-border operating group ……stress testing programmes and
We welcome the IFSB’s effort in promoting home-host supervision over IIFS’s stress testing practices. Although it seems to have been implied in the relevant requirements, it could help avoid doubt and smooth the work of host supervisors if the IFSB could explicitly specify in ED13 that The host supervisors may require the local operations of an IIFS (be it a branch or a locally incorporated subsidiary) to include stress scenarios that reflect its risks and vulnerabilities in the context of local markets, and the local operations should provide the host supervisors with relevant stress testing results and any other information they may need to
Agreed. This suggestion of the HKMA is well taken and is reflected in a new Paragraph 177, that is, “The host supervisory authorities may also require the local operations of an IIFS (be it a branch or a locally incorporated subsidiary) to include stress scenarios that reflect its risks and vulnerabilities in the context of local markets, and the local operations should provide the host supervisory authorities with relevant stress testing results and any other
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their results should be discussed by the respective supervisory authorities on a regular basis.....
fully assess the stress impact on the local operations. HKMA
information they may need to fully assess the stress impact on the local operations”.
Principle 4.6: Supervisory authorities should conduct stress tests at the macro level in their respective jurisdictions at suitable intervals, as well as identifying particular IIFSs that are more sensitive to economic stress in their jurisdictions. They should determine the appropriate qualitative and quantitative disclosures with respect to stress testing to be submitted by the IIFS in their jurisdiction. Supervisory authorities should also provide a standardised reporting format to IIFS that carry out stress testing exercises. 332.
Principle 4.6
We agree to this principle. KFHK
No change. Noted.
333.
Principle 4.6
Such stress-test parameters / templates must also give due considerations to complexity of the economy in which banks are operating. For example, stress-testing regulations for banks operating with complex and open economy (such as America) is expected to be more rigorous whereas stress-testing regulations for banks operating in simple and highly regulated economies (such as Bahrain) should be made simpler. ITB
No change. It is already being addressed by the ED in the paragraphs under Principle 4.6 and it is expected from supervisory authorities to take into account their local context when finalizing the templates for stress tests.
334.
Principle 4.6
We would suggest that banks are given an opportunity for consultation by the supervisor on the disclosure and reporting requirements prior to formal adoption. SAMA
No change. Noted. This is expected and it is already standard practice across the jurisdictions where supervisory authorities do consult with market players before finalising certain regulations.
335.
Principle 4.6, Paragraph 146
The consistency of stress test process and reporting across the IIFS within jurisdictions is of great importance and hence comprehensive guidelines/standardised reporting formats (Principle
No change. Noted. See response in (334) above.
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4.6) from the supervisors of each jurisdiction needs to be formalised and discussed with the banks. KFHB
336.
Principle 4.6, Paragraph 146
"Unified Reporting Mechanism", which is in direct conflict with section 2.3 "Relevance of Stress Testing and Sophistication of IIFS, which advises institutions to adopt stress testing after consideration of their size and complexity. SAMA
Agreed with the observation. In addition, though clarity on “proportionality” in the scope and complexity of stress testing requirements would be subject to relevant supervisory authority, nevertheless, in order to create consistency, the Paragraph 180 is adjusted to reflect the Section 2.3 considerations. In this regard, the word “standardised” from the Paragraph 180 and main Principle 3.22 is removed which conflict with Section 2.3 and scope of the ED. Instead a “reporting format” is maintained and whole paragraph is reworded and this will be in consistent with the Section 2.3 and sophistication of the IIFS.
337.
Principle 4.6, Paragraph 146 on p.51 - . however, adherence to a reporting format for the results of stress testing submitted by the IIFS to the supervisory authorities across the financial system is vital to achieve consistency. In this regard, supervisory authorities should provide a standardised reporting format to those IIFS which
It is intended that the “principle of proportionality is applicable to all aspects of these Guiding Principles,” (para.13 on p.4). Moreover, IIFS differ in their size, sophistication, complexity, risk tolerance and financial/capital/liquidity strengths. There are also a number of approaches, scenarios, methodologies and practices that differ in assumptions, technicality, coverage and severities that IIFS could adopt for stress testing. As such, the use of a standardised reporting format by all IIFS
Agreed. It will be difficult for the supervisory authorities to provide standardised reporting format given that IIFS differ in their size, sophistication, complexity, risk tolerance and also there are a number of approaches, scenarios, methodologies and practices that differ in assumptions. However, taking
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carry out stress testing exercises.) cannot ensure comparability and meaningful interpretations of stress testing results among the institutions. The IFSB may wish to clarify how different IIFS’s stress testing submissions will be monitored and interpreted taking account of the specific circumstances of individual institutions and potential comparability issues. HKMA
into account the concept of proportionality, supervisory authorities will still have to provide relevant reporting format to different types of IIFS. As noted above (336) that the word “standardised” from the paragraph 146 and main Principle 4.6 removed which conflict with section 2.3 and scope of the ED. Instead a “reporting format” is maintained and whole paragraph is reworded and this will be in consistent with the Section 2.3 and sophistication of the IIFS.
338.
Paragraph 146 on p.51 - ….. however, adherence to a reporting format for the results of stress testing submitted by the IIFS to the supervisory authorities across the financial system is vital to achieve consistency. In this regard, supervisory authorities should provide a standardised reporting format to those IIFS which carry out stress testing exercises.)
We support the issues raised in the survey report especially with regard to use of national parameters. In this respect, the STWG may already be aware of the experience of the banks in Sultanate of Oman during this year (2011) where the Central Bank of Oman ("CBO") issued standardized stress-testing templates to be used by banks licensed by the CBO. IFSB may want to consider similar approach. An important reason for considering standardized (or unified) parametric calculation guidelines across all banks is that it will, at least, result in fair benchmarking and therefore unbiased treatment by regulatory authorities. Failure to do so, there will always be the danger that banks may exploit the situation and define stress tests only in a moderate way. This will prejudice any attempt at an impartial identification of risks that may be conceived as genuine threats. This concern must adequately be addressed by the Exposure-Draft.
No change. The importance of having a reporting format has been addressed under Principle 4.6. Providing a comprehensive guidance on the parametric calculation process and coverage a format for stress testing, may be addressed separately under the implementation guidance (if issued by the IFSB in due course) on stress testing, which can take into account various possibilities. The implementation guidance can provide a strategy in implementing the Guiding Principles, perhaps in stages, i.e. simple, intermediate and advanced approaches. As noted above (337) that it will be quite difficult for the supervisory authorities to provide standardized
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ITB
reporting format given that IIFS differ in their size, sophistication, complexity, risk tolerance and also there are a number of approaches, scenarios, methodologies and practices that differ in assumptions. However, taking into account the concept of proportionality, supervisory authorities will still have to provide relevant reporting format to different types of IIFS.
339.
Supervisor should provide standard format for calculating basic stress testing exercise which should be agreed and understood bank wide by all IIFS.
BBP
Agreed. It is being reflected in the paragraph. It is expected from the supervisory authorities to provide reporting format. See above responses (336), (337) and (338) as well.
DEFINITIONS 340.
Definitions – General Comment
We understand that, for avoidance of doubt, it should be mentioned in the definitions of all sale-based contracts (Murabaha, Salam, Istisna, Ijara, etc.) that the purchase price (or lease rental for the lease period in case of Ijara) must be known on the date of signing of the contract. DIB
No change. All the definitions have been vetted through the Shari’ah Advisory Committee of the IDB and these definitions are consistent with previous IFSB standards. However, the suggestions would be tabled to the Committee for its discussion.
341.
Definition of Commodity Murabahah
Do we need to differentiate between normal commodity Murabahah transactions and those based on Organized Tawarruq?
No change. This is the scope of this document. Please see IFSB Guidance Note in Connection with the Risk
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DIB Management and Capital Adequacy Standards: Commodity Murābahah Transactions, December 2010, for more detail. The term "Commodity Murābahah transactions as a tool for liquidity management (CMT)" means a Murābahah-based purchase and sale transaction of Sharī`ah-compliant commodities, whether on cash or deferred payment terms. The definition is consistent with IFSB GN-2.
342.
Definition of Mudaraba
Mudaraba is described as partnership contract. It should be defined in view of the Sharia rulings which are different from that of partnership/Musharaka. Moreover, mechanism of incentive (as used by almost all the IIFS’s) should also be incorporated in the definition. DIB
No change. This definition has been vetted through the Shari’ah Advisory Committee of the IDB and this definition is consistent with previous IFSB standards.
343.
Definition of Sukuk
Sukuk represent Undivided Ownership of the Sukukholders and mentioning the ownership as “ownership right” is not appropriate. The word “right” should be deleted from the definition. DIB
No change. See response in (342) above.
344.
Definition of Salam
Please adopt the definition from Guiding Principles on Liquidity Risk Management. DIB
Agreed. It has been revised. Please see the revised definition of Salam in the revised draft.