stress & reverse stress from a macro viewpoint€¦ · 7 stress testing: 4- modelling...

Stress & Reverse Stress from a Macro Viewpoint

Dr. Juan M. Licari

Senior Director

Head of Economic & Credit Analytics - EMEA

2

Stress & Reverse Stress Testing from a Macro Viewpoint

Key Stress Testing Challenges:

1- Dynamic vs. Static Approach to Stress Testing,

2- Partial vs. General Equilibrium,

3- Top-down vs. Bottom-up,4- Modelling Methodologies: Stress Testing vs.

Forecasting/Scoring,

5- Quantitative Reverse Stress Testing,

6- Looking beyond Capital & Solvency.

Historic and predicted default rates (baseline),

% of balance at origination

Consolidated portfolio, vintages over time

Performance of Future Loans

Forecasted Performance of Existing LoansPerformance History

3

Stress Testing: 1- Dynamic vs. Static Approach

4

Stress Testing: 2- Partial vs. General EquilibriumExample of top-down stress testing approach, Bank of England’s RAMSI model

5

Stress Testing: 2- Partial vs. General Equilibrium

» Interest rates

» Unemployment rates

» Income growth

» Profits (National Accounts)

» Share market

Small Business Loans

» Interest rates

» Unemployment rate

» Commodity/oil prices

» Price index for used cars

Auto-Equipment Loan/Lease

Illustrative

» Mortgage rate difference from origination

» Unemployment rate

» Employment growth

» Income growth

» House price growth

» Home equity

RMBS

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

2009

M06

2009

M10

2010

M02

2010

M06

2010

M10

2011

M02

2011

M06

2011

M10

2012

M02

2012

M06

2012

M10

2013

M02

2013

M06

2013

M10

Baseline

S3

S4

DD

0

10

20

30

40

50

60

70

80

90

10020

09M

0620

09M

1120

10M

0420

10M

0920

11M

0220

11M

0720

11M

1220

12M

0520

12M

1020

13M

0320

13M

0820

14M

0120

14M

0620

14M

1120

15M

0420

15M

09

Baseline

S3

S4

DD

PD term-structure

LGD curves

Examples of collateral type for RMBS/ABS deals

6

Stress Testing: 3- Top-down vs. Bottom-up

Issue: Loan level model can miss correlations and feedback effects

» Individual performance depends on other loans

» Difficult to model individuals within a system

Risk models could miss the forest for the trees

– Why not model the forest, model the trees and then make sure

the tree model agrees with forest projections?

≠

7

Stress Testing: 4- Modelling Methodologies0

.2.4

.6.8

1

Tra

nsitio

n %

2000m1 2002m1 2004m1 2006m1 2008m1 2010m1 2012m1Month of Transition

Binary_Probit_Regression O_1_Median_Variable

0.2

.4.6

.81

Tra

nsitio

n %

2000m1 2002m1 2004m1 2006m1 2008m1 2010m1 2012m1Month of Transition

Binary_Probit_Regression O_1_Median_Variable

Binary (Probit) Model Downgrade0

.1.2

.3.4

Tra

nsit

ion

%

2000m1 2002m1 2004m1 2006m1 2008m1 2010m1 2012m1 2014m1 2016m1Month of Transition

Actuals Baseline

FSA Scenario4

Custom

0.0

2.0

4.0

6.0

8T

ran

sitio

n %

2000m1 2002m1 2004m1 2006m1 2008m1 2010m1 2012m1 2014m1 2016m1Month of Transition

Actuals Baseline

FSA Scenario4

Custom

CaaC to DefaultBaa to A

Binary (Probit) Model Upgrade

-60

-40

-20

0

20

40

60

20

01

M9

20

02

M4

20

02

M1

1

20

03

M6

20

04

M1

20

04

M8

20

05

M3

20

05

M1

0

20

06

M5

20

06

M1

2

20

07

M7

20

08

M2

20

08

M9

20

09

M4

20

09

M1

1

20

10

M6

20

11

M1

20

11

M8

20

12

M3

20

12

M1

0

20

13

M5

20

13

M1

2

20

14

M7

20

15

M2

20

15

M9

20

16

M4

Equity Forecasts, Annual Returns

tyy_ukxindex_bl

tyy_ukxindex_fsa

tyy_ukxindex_s4

-60

-40

-20

0

20

40

60

20

01

M9

20

02

M4

20

02

M1

1

20

03

M6

20

04

M1

20

04

M8

20

05

M3

20

05

M1

0

20

06

M5

20

06

M1

2

20

07

M7

20

08

M2

20

08

M9

20

09

M4

20

09

M1

1

20

10

M6

20

11

M1

20

11

M8

20

12

M3

20

12

M1

0

20

13

M5

20

13

M1

2

20

14

M7

20

15

M2

20

15

M9

20

16

M4


tyy_spxindex_bl

tyy_spxindex_fsa

tyy_spxindex_s4

-60

-40

-20

0

20

40

60

20

01

M8

20

02

M3

20

02

M1

0

20

03

M5

20

03

M1

2

20

04

M7

20

05

M2

20

05

M9

20

06

M4

20

06

M1

1

20

07

M6

20

08

M1

20

08

M8

20

09

M3

20

09

M1

0

20

10

M5

20

10

M1

2

20

11

M7

20

12

M2

20

12

M9

20

13

M4

20

13

M1

1

20

14

M6

20

15

M1

20

15

M8

20

16

M3


tyy_mxwoindex_bl

tyy_mxwoindex_fsa

tyy_mxwoindex_s4

8

Equity Indexes, annual growth rateHistory and forecasts

World US

UK

Stress Testing: 4- Modelling Methodologies

9

-40

-20

0

20

40

60

80

100

120

20

02

M1

20

02

M7

20

03

M1

20

03

M7

20

04

M1

20

04

M7

20

05

M1

20

05

M7

20

06

M1

20

06

M7

20

07

M1

20

07

M7

20

08

M1

20

08

M7

20

09

M1

20

09

M7

20

10

M1

20

10

M7

20

11

M1

20

11

M7

20

12

M1

20

12

M7

20

13

M1

20

13

M7

20

14

M1

20

14

M7

20

15

M1

20

15

M7

20

16

M1

20

16

M7

20

17

M1

20

17

M7

20

18

M1

Corporate Spread, Aaa Financials, 03m

f_aaa_f3m_bl

f_aaa_f3m_fsa

f_aaa_f3m_s4

0

50

100

150

200

250

300

20

02

M1

20

02

M7

20

03

M1

20

03

M7

20

04

M1

20

04

M7

20

05

M1

20

05

M7

20

06

M1

20

06

M7

20

07

M1

20

07

M7

20

08

M1

20

08

M7

20

09

M1

20

09

M7

20

10

M1

20

10

M7

20

11

M1

20

11

M7

20

12

M1

20

12

M7

20

13

M1

20

13

M7

20

14

M1

20

14

M7

20

15

M1

20

15

M7

20

16

M1

20

16

M7

20

17

M1

20

17

M7

20

18

M1

Corporate Spread, Aaa Financials, 10y

f_aaa_f10y_bl

f_aaa_f10y_fsa

f_aaa_f10y_s4

-100

-50

0

50

100

150

200

20

02

M1

20

02

M8

20

03

M3

20

03

M1

0

20

04

M5

20

04

M1

2

20

05

M7

20

06

M2

20

06

M9

20

07

M4

20

07

M1

1

20

08

M6

20

09

M1

20

09

M8

20

10

M3

20

10

M1

0

20

11

M5

20

11

M1

2

20

12

M7

20

13

M2

20

13

M9

20

14

M4

20

14

M1

1

20

15

M6

20

16

M1

20

16

M8

20

17

M3

20

17

M1

0

20

18

M5

Corporate Spread, Aaa Non-Financials, 03m

f_aaa_nf3m_bl

f_aaa_nf3m_fsa

f_aaa_nf3m_s4

-50

0

50

100

150

200

250

300

20

02

M1

20

02

M7

20

03

M1

20

03

M7

20

04

M1

20

04

M7

20

05

M1

20

05

M7

20

06

M1

20

06

M7

20

07

M1

20

07

M7

20

08

M1

20

08

M7

20

09

M1

20

09

M7

20

10

M1

20

10

M7

20

11

M1

20

11

M7

20

12

M1

20

12

M7

20

13

M1

20

13

M7

20

14

M1

20

14

M7

20

15

M1

20

15

M7

20

16

M1

20

16

M7

20

17

M1

20

17

M7

20

18

M1

Corporate Spread, Aaa Non-Financials, 10y

f_aaa_nf10y_bl

f_aaa_nf10y_fsa

f_aaa_nf10y_s4

Stress Testing: 4- Modelling Methodologies

10

Stress Testing: 5- Reverse Stress Testing

Portfolio Expected Values – Defining Severity

Scenario 2

5, 10, 100 bps

Baseline

5, 10, 100 bps

Incr. SR

11


12

Analyzing Factors’ Realizations Across Tail Events


13

-50

5g

dp

gro

wth

-3-2

-10

1fa

cto

r 1

2000q1 2003q1 2006q1 2009q1 2012q1

factor 1 gdp growth

2000Q1-2011Q4: Factor 1 vs GDP growth.

-3

-2

-1

0

1

2

3

4

5

2006 2007 2008 2009 2010 (E) 2011 (F) 2012 (F) 2013 (F) 2014 (F)

Simulations of Inflation Rate, History & Forecasts, Euro-

Zone Level

0

50

100

150

200

250

300

less

th

an

-3

-3 t

o -

1.5

-1.5

to

0

0 t

o 1

.5

1.5

to

3

3 t

o 4

.5

4.5

to

6

6 t

o 7

.5

7.5

to

9

9 t

o 1

0.5

10

.5 t

o 1

2

ov

er

12

Historic

2012Q1

2014Q1

2016Q1

Simulations of Real GDP Growth, Emerging Markets

Standard Alternative Scenarios

Macro Factor Analysis

Linking Factors’ Realizations to Macro Scenarios


14

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RRRRoooottttaaaattttiiiioooonnnn:::: ((((uuuunnnnrrrroooottttaaaatttteeeedddd)))) NNNNuuuummmmbbbbeeeerrrr ooooffff ppppaaaarrrraaaammmmssss ==== 222200003333 MMMMeeeetttthhhhoooodddd:::: pppprrrriiiinnnncccciiiippppaaaallll ffffaaaaccccttttoooorrrrssss RRRReeeettttaaaaiiiinnnneeeedddd ffffaaaaccccttttoooorrrrssss ==== 11114444FFFFaaaaccccttttoooorrrr aaaannnnaaaallllyyyyssssiiiissss////ccccoooorrrrrrrreeeellllaaaattttiiiioooonnnn NNNNuuuummmmbbbbeeeerrrr ooooffff oooobbbbssss ==== 44448888

UK Factor Analysis – Top 5 Factors

UK factor analysis – 21 macroeconomic series

Stress Testing: 5- Reverse Stress TestingLinking Factors’ Realizations to Macro Scenarios

15

-10

-50

5g

dp

gro

wth

-3-2

-10

1fa

cto

r 1

2000q1 2003q1 2006q1 2009q1 2012q1

factor 1 gdp growth

UK, 2000-2012: Factor 1 vs GDP growth

-2-1

01

2e

mp

loym

en

t g

row

th

-2-1

01

2fa

cto

r 2

2000q1 2003q1 2006q1 2009q1 2012q1

factor 2 employment growth

UK, 2000-2012: Factor 2 vs Growth in Employment

Stress Testing: 5- Reverse Stress TestingLinking Factors’ Realizations to Macro Scenarios, UK Top Factors

-6-4

-20

2in

fla

tio

n (

-)

-3-2

-10

12

facto

r 3

2000q1 2003q1 2006q1 2009q1 2012q1

factor 3 inflation (-), lagged

UK, 2000-2012: Factor 3 vs Inflation

-6-4

-20

mo

ne

tary

po

licy (

-)

-3-2

-10

12

facto

r 3

2000q1 2003q1 2006q1 2009q1 2012q1

factor 3 monetary policy (-)

UK, 2000-2012: Factor 3 vs Monetary Policy rate

-12

-10

-8-6

-4-2

M1

gro

wth

-2-1

01

2fa

cto

r 4

2000q1 2003q1 2006q1 2009q1 2012q1

factor 4 M1 growth

UK, 2000-2012: Factor 4 vs M1 (growth rate)

-30

-20

-10

01

02

0H

om

e P

rice

gro

wth

-10

12

3fa

cto

r 5

2000q1 2003q1 2006q1 2009q1 2012q1

factor 5 Home Price Index growth (lagged)

UK, 2000-2012: Factor 5 vs Home Price growth (lagged)

16

Stress Testing: 6- Looking beyond Capital & Solvency

Bank A Bank B

Bank D Bank C

Bank A Bank B

Bank D Bank C

Bank B1 Bank B2 Bank B3 Bank B4

Bank A1 Bank A2

Bank A3 Bank A4

Bank B5 Bank B6 Bank B7 Bank B8

Case 1: Incomplete Markets Case 2: Complete Markets

Case 3: A Hybrid Market Structure

17

(1) If a small institution fails, other peripheral banks are likely to suffer asset-liability mismatches. But the systemic risk involved is not as high. Large institutions should be able to absorb the original shock and stop the domino effects once it enters the core banking area.

(2) If the shock is to one of the large financial institutions, there is a secondary effect through the overall health of the financial economy that could put all institutions under tremendous pressure.

Though the core banking sub-sector is complete (bi-directional flows), the fact that it is highly concentrated poses severe challenges to the banking sector as a whole. It is not so much a direct domino effect between, say, Bank A1 and Bank A2, but an indirect

contagion risk: (2.a) Bank A1 affects the overall economy (as it is a big financial institution whose failure can put pressure on the local financial and labor markets), (2.b) the economy affects Bank A2 as an external shock, (2.c) Bank A2’s failure worsens the economic picture even more, (2.d) the economy affects Bank A3, etc.

.04

.045

.05

.055

.06

130 140 150 160 170qtime

ff_pl_pct_ast_tot_bl ff_pl_pct_ast_tot_s2

ff_pl_pct_ast_tot_s3 ff_pl_pct_ast_tot_s4

ff_pl_pct_ast_tot_s5 ff_pl_pct_ast_tot_s6

P&L Rate, Total Assets

2010 2011 2012 2013 2014

.015

.02

.025

.03

130 140 150 160 170qtime

ff_pl_pct_liab_tot_bl ff_pl_pct_liab_tot_s2

ff_pl_pct_liab_tot_s3 ff_pl_pct_liab_tot_s4

ff_pl_pct_liab_tot_s5 ff_pl_pct_liab_tot_s6

P&L Rate, Total Liabilities

2010 2011 2012 2013 2014

Stress Testing: 6- Looking beyond Capital & Solvency

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stress & reverse stress from a macro viewpoint€¦ · 7 stress testing: 4- modelling...

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