Model risk management principles for stress testing – CP26/17
This consultation paper (CP) sets out the Prudential Regulation Authority’s (PRA’s) proposals to support effective practices in model risk management for stress testing. A set of principles has been developed in the context of the annual concurrent stress testing process, which tests the resilience of the banking system and some of the largest firms within it. The PRA proposes to embed these principles further for firms participating in the annual concurrent stress tests, while also extending them, in a proportionate manner, to the wider banking sector.
The CP is relevant to PRA-authorised banks, building societies and PRA-designated investment firms (‘firms’). Credit unions are not in scope and there is currently no proposal to extend the principles to insurance and reinsurance firms
Summary of proposals
The primary objective of stress testing is to help regulators and firms assess capital positions under adverse economic conditions. This exercise allows regulators to help inform the setting of capital requirements for both microprudential and macroprudential purposes. Banks are also increasingly using stress results of stress tests to inform strategic and business decisions.
Taking a proportionate approach, the PRA proposes:
(a) that firms participating in the Bank’s annual concurrent stress test should adopt the principles for all stress test models; and
(b) firms not participating in the Bank’s annual concurrent stress testing should take into account their size, nature, scale, complexity of business activities and use of stress test models when seeking to apply the principles. For these firms the PRA proposes at a minimum:
(i) implementation of Principles 1 and 2 (ie establish a model definition, maintain a model inventory and implement an effective governance framework, policies and procedures); and
(ii) application of Principles 3 and 4 (ie implement a robust model development process and undertake validation and independent review) to models they have identified as material
Responses and next steps
This consultation closes on Tuesday 6 March 2018. The PRA invites feedback on the proposals set out in this consultation. The PRA is particularly interested in respondent’s’ views on the usefulness and applicability of the proposed principles for firms not participating in the Bank’s annual concurrent stress test. Please address any comments or enquiries to CP26_17@bankofengland.co.uk.