The COSO Framework for Internal Control
February 12, 2025
A strong association between individuals sharing similar interest and goal is called as interpersonal relationship. It is important to have trustworthy colleagues around at the workplace. One needs to know how to interact with fellow workers. Let us go through some interpersonal skills an individual needs to inculcate for a healthy relationship with coworkers. Stay […]
While the gender ratio was hovering around 930-950 throughout the earlier decades when there were fewer women than men as a statistical fact, this has become more alarming in recent years because the number is falling rapidly. When taken together with the overall increase in population of India that has a large percentage of young […]
Conflict arises when individuals opine in dissimilar ways or have varied interests, attitudes and even perceptions. Misunderstandings among individuals and ego clashes also result in a conflict. Conflict can arise any time and at any place when individuals are not willing to adjust with each other and are adamant on their views and thoughtprocesses. One […]
Introduction Humans are social animals and hence, form groups wherever they are. This is true for organizations as well as familial and friendship networks wherein people tend to congregate in groups and be governed by the norms and rules of the group. For instance, familial groups impose a certain way of behavior in us as […]
What is Agile and what is meant by the VUCA World? It is hard not to miss the extensive press coverage for the Agile Methodology that is taking the corporate world by storm. Indeed, this innovative, flexible, and adaptable way of doing things and ordering work has been credited by leading business leaders for its […]
In the previous article, we have already studied how expected and unexpected losses are calculated using statistical techniques. However, there are certain events and their associated credit risks which are not captured by the analyses mentioned above. In order to include them in the calculation, another technique called stress testing is used.
In this article, we will have a closer look at what stress testing is as well as the different types of stress testing techniques present in the market.
Stress testing is the process of seeing how the values in a portfolio change in reaction to an extreme event in the environment. In this case, the portfolio refers to the portfolio of credit risks.
It needs to be noted that stress testing techniques can also be applied to other market instruments. Also, stress testing is not done for regular scenarios. The changes in the external environment have to be extreme yet possible. The credit analyst has to conjure up several black swan events using their imagination and run simulations on the same for the stress testing exercise to be successful.
The event which triggers the stress test can be of various types. In some cases, the default of an important counterparty may be considered. In some other cases, the collapse of entire industries or economies will be modeled using stress testing techniques. Other extreme events such as a change in interest rates are also simulated if the company has a lot of debt which is linked to benchmark rates such as LIBOR.
Stress testing is a subject by itself. This subject has shot to prominence after the 2008 credit crisis. Several different forms of stress testing are commonly used today. Some of these common techniques have been listed below:
For instance, the interest rate can be varied and the output can be checked at different levels to understand how sensitive the company is to interest rate risks. Sensitivity analysis can be carried out on more than one parameter. For instance, first, the company can vary only the interest rate, and then later it can vary only the expected loss value.
Hence, empirical data must be present if such an analysis has to be conducted. The benefit of historical analysis is that this method is not subjective and hence analysts cannot influence the calculation too much. However, in many industries, the past trends may not be likely to repeat in the future. Hence, the analysis becomes futile and irrelevant.
Stress testing is an invaluable tool that has gained prominence in recent years. However, in most cases, it has been used to manage market risks. However, of late, it has been used extensively in the management of credit risks as well.
Your email address will not be published. Required fields are marked *