Risk Stress Testing Research Articles

Influence of Expected Loan Loss on Operational Performance of Commercial Banks in Kenya

Purpose: The main objective of this study was to examine influence of credit risk stress testing on operational performance of commercial Kenya. The theoretical framework was based on credit risk theory. Methodology/Approach: The study used all commercial banks which are 42 it total. The adopted mixed research comprising of causal and longitudinal research designs. The study used secondary data from operational statements of banks. Descriptive applied involved skewness, kurtosis, mean and standard deviation. Multiple regression analysis was also applied. Data was presented using tables. Findings: The results revealed that expected loan loss lead to performance of commercial Banks as shown by a positive and significant coefficient of in the regression model in a fixed effect model. Implications: The study suggested that operational institutions implement a stringent policy that escalates the loss in the event of default, thereby restricting loan approvals to clients who can guarantee they will repay the loan in full.

Organization and methodology of stress testing of banking risks

The paper identifies stress testing as an important tool that helps the NBU and banking institutions effectively manage risks. The importance of stress testing is determined by the possibilities of: assessing the stability of banks, identifying vulnerable places, increasing transparency and trust, preparing for crisis situations, improving policies and procedures. It has been proven that the effective conduct of stress testing allows: to ensure the stability of the banking institution, to identify vulnerabilities, to increase transparency and trust, to prepare for crisis situations, to improve policies and procedures. It was determined that the NBU plays a key role in conducting stress testing, providing supervision of the banking system and determining general approaches to assessing the stability of banks by establishing regulatory requirements, analyzing the results of stress testing, developing policies and recommendations for banks. It is shown that the main aspects of credit risk stress testing are: assessment of the impact on the credit portfolio, analysis of financial indicators, sensitivity to risks, development of preventive measures, capital planning, systematic approach to credit risk monitoring. The banking institution uses the results of stress testing to develop a strategy and business plan, risk management policies and procedures, and business recovery plans. The methodology of stress testing of credit risk, liquidity risk, interest rate risk of the bank book, market risk, and operational risk has been formalized, which should be carried out at least once a quarter. The purpose of stress testing and assumptions for developing stress scenarios for each type of risk are defined. Recommendations for improving the organization of the stress testing process have been developed. A set of measures to improve the mechanism of stress testing of banking activity risks is substantiated: development of unified methods and algorithms of stress testing, harmonization of national approaches with international standards, integration of stress testing into the risk management system, technological support and automation of processes, improvement of personnel qualifications.

Risk factor aggregation and stress testing

Stress testing refers to the application of adverse financial or macroeconomic scenarios to a portfolio. For this purpose, financial or macroeconomic risk factors are linked with asset returns, typically via a factor model. We expand the range of risk factors by adapting dimension-reduction techniques from unsupervised learning, namely PCA and autoencoders. This results in aggregated risk factors, encompassing a global factor, factors representing broad geographical regions, and factors specific to cyclical and defensive industries. As the adapted PCA and autoencoders provide an interpretation of the latent factors, this methodology is also valuable in other areas where dimension-reduction and explainability are critical.

Optimizing risk management in oil and gas trading: A comprehensive analysis

The oil and gas trading sector is inherently volatile, influenced by geopolitical events, market dynamics, and regulatory changes. Effective risk management is crucial for mitigating these uncertainties and ensuring operational stability and profitability. This paper presents a comprehensive analysis of optimizing risk management in oil and gas trading, highlighting strategies, tools, and best practices to manage and mitigate risks. Risk management in oil and gas trading encompasses a broad spectrum of activities, including market risk, credit risk, operational risk, and compliance risk. To optimize risk management, firms must employ a multifaceted approach that integrates advanced analytics, robust risk assessment frameworks, and strategic decision-making processes. Key strategies include the use of financial instruments such as futures, options, and swaps to hedge against price volatility. These instruments enable traders to lock in prices and margins, thereby reducing exposure to market fluctuations. Advanced analytics and data-driven decision-making are essential components of effective risk management. By leveraging big data, machine learning, and artificial intelligence, traders can gain deeper insights into market trends, forecast price movements, and identify potential risks. Predictive analytics allows for proactive risk management, enabling firms to anticipate and respond to market changes swiftly. A comprehensive risk assessment framework is also critical. This involves regular monitoring and evaluation of risk exposure, stress testing, and scenario analysis. Such practices help identify vulnerabilities and ensure that risk mitigation measures are in place. Additionally, fostering a risk-aware culture within the organization is vital. This includes training and educating employees on risk management practices and encouraging transparent communication and reporting of risks. Compliance risk, driven by regulatory changes, is another significant aspect of risk management in oil and gas trading. Staying abreast of regulatory developments and ensuring compliance with international and local regulations is essential to avoid legal penalties and reputational damage. Implementing robust compliance programs and leveraging technology to monitor regulatory changes can help firms stay compliant. In conclusion, optimizing risk management in oil and gas trading requires a holistic approach that combines financial hedging, advanced analytics, comprehensive risk assessment, and compliance management. By adopting these strategies, firms can effectively mitigate risks, enhance decision-making, and achieve sustainable growth in a highly volatile industry. Keywords: Optimizing, Risk Management, Oil and Gas, Trading, Analysis.

Effect of Probability of Default and Financial Performance of Commercial Banks in Kenya

Purpose: Specific objectives are to establish the effect of effect of probability of default and financial performance of Commercial Banks in Kenya. The theoretical framework was based on asymmetric information. Methodology/Approach: The adopted mixed research comprising of causal and longitudinal research designs. The study used all commercial banks which are 42 it total. Positivism research philosophy was adopted. The study used secondary data from financial statements of banks. Data was analyzed by both descriptive and inferential statistics. Data was presented using tables. Findings: From the findings Probability of default negatively affects the Performance of Commercial Banks in Kenya as indicated by a p value of 0.00 in the fixed effect model. This can be explained as a result of the following possible factors: Loans with higher Probability of default are more likely to become non-performing assets or be classified as doubtful debts. Implications: Implementing a credit risk stress testing plan can effectively mitigate the likelihood of a bank encountering a financial crisis. In order to mitigate liquidity risk, it is advisable for banks to augment their liquid holdings.

Climate Risk Stress Test: Impact of Climate Change on the Peruvian Financial System

Climate Risk Stress Test: Impact of Climate Change on the Peruvian Financial System

Latent fragility: Conditioning banks' joint probability of default on the financial cycle

We propose the CoJPoD, a novel framework explicitly linking the cross-sectional and cyclical dimensions of systemic risk. In this framework, banking sector distress in the form of the joint probability of default of financial intermediaries (reflecting contagion from both direct and indirect interconnectedness) is conditioned on the financial cycle (reflecting the buildup and unwinding of system-wide balance-sheet leverage). An empirical application to large systemic banks in the euro area, US and UK illustrates how the unraveling of excess leverage can magnify banking sector distress, including during the 2023 US banking sector turmoil. Capturing this dependence of banking sector distress on prevailing financial imbalances can enhance risk surveillance and stress testing alike. An empirical signaling exercise confirms that the CoJPoD outperforms the individual capacity of either its unconditional counterpart or the financial cycle in signaling financial crises – particularly at their onset – suggesting scope to increase the precision with which macroprudential policies are calibrated.

Climate Threats to Bank Default Risk and Financial Stability: Any Market Concern about the ECB 2022 Climate Risk Stress Test?

Climate Threats to Bank Default Risk and Financial Stability: Any Market Concern about the ECB 2022 Climate Risk Stress Test?

МОНИТОРИНГ БАНКОВСКИХ РИСКОВ В УСЛОВИЯХ ПЕРЕХОДА К УСТОЙЧИВОМУ РАЗВИТИЮ

The article deals with the analysis of banking risks under the transition to sustainable development (Environmental, Social, and Governance risks, ESG risks). The study examined the main Environmental, Social and Governance (ESG) factors as well as risks regarding their integration. It has been established that today in Russian practice, there is a lack of mechanisms for controlling and monitoring of such risks, thus leading to a decrease in the financial performance of a credit organization should any of these risks arise. In this regard, at the initial stages of integrating ESG factors, it is recommended to utilize one of the methods of a simplified monitoring system: consider ESG risks in the current risks system or use ESG risk stress test tools. The study’s findings can be used to advance theoretical and empirical developments on issues related to the integration of ESG factors.

Spurious Default Probability Projections in Credit Risk Stress Testing Models

Spurious Default Probability Projections in Credit Risk Stress Testing Models

The Current State and Challenges of Financial Risk Management

Financial risk management is a critical discipline in today's dynamic and interconnected financial landscape. This article explores various facets of financial risk management, including the challenges posed by rapid technological advancements, globalization, cybersecurity threats, regulatory changes, and economic uncertainty. It also discusses strategies for effective risk management, such as integrated risk management approaches, advanced analytics, stress testing, risk culture, and communication. Additionally, the article highlights the importance of continuous research and innovation in risk management and offers insights into future trends, including emerging technologies, regulatory reforms, and adaptation to economic and market changes. The conclusion emphasizes the need for proactive, adaptive risk management practices to navigate the complexities of the financial risk landscape successfully.

ESG as a key pillar of investment strategy

In this paper we delve into the importance of environmental, social and governance (ESG) considerations as a cornerstone in investment strategies. The discourse takes the reader through a transformative journey, from understanding key pillars that need to be addressed to truly succeed in ESG integration to setting the level of strategic ambition to incorporate it effectively into investment processes, focusing particularly on integration and management. We explore key steps in an investment process, such as strategic allocation, security selection, portfolio construction with a particular emphasis on risk assessment, stress testing and investment compliance. Specific examples are provided to elucidate how ESG considerations can be seamlessly incorporated into these critical steps to achieve fully aligned portfolios. Upon completion of the paper, readers can expect to gain a robust understanding of the ESG landscape, insights on how to integrate ESG considerations into their investment decisions and tools to future-proof their portfolios. The knowledge and skills acquired will be invaluable for asset managers, investors and other finance professionals looking to align their strategies with the emerging realities of the current investment landscape.

The marginal impact of predicted climate risk scenarios on portfolio credit risk stress testing

This paper adapts the methodology developed by de Oliveira Campino et al. (June 2021) to account for predicted climate risk shocks' impact on a sovereign portfolio's credit quality on a forward-looking basis and in probabilistic terms. In particular, the portfolio stress testing capability is enhanced by adjusting the severity of the credit shocks to account for climate risk-related events on an additive basis. The benefit to risk managers is that it allows understanding of the impact of climate risk in marginal terms in relation to the original credit shock. The recently created NGFS (the Network for Greening the Financial System) database makes this exercise possible. Moreover, the described approach translates the marginal impact of climate risk scenarios on the portfolio's credit risk stress testing into capital adequacy metrics dislocations, which facilitates communicating the marginal impact of climate risk scenarios as capital consumption amounts. The paper presents an overview of the underlying model, and the methodological approach developed to adapt the credit risk stress-testing capabilities to account for climate risk using the NGFS database. Moreover, it applies the methodology to a hypothetical sovereign loan portfolio and discusses the results. Over the period considered, the study finds that the transition aspect of climate risk has a more pronounced marginal impact on a sovereign portfolio's credit risk than the chronic physical aspect of climate risk. Moreover, the results indicate that as the world takes action to transition away from carbon, the credit risk of sovereign portfolios may be exacerbated, especially if there are delays and a lack of coordination across countries and sectors.

Financial risk under the shock of global warming: Evidence from China

AbstractThe economic and financial risks of global warming have become a hot issue of academic interest. This article analyzes global warming, financial risk, and the economic statistics of 30 provinces in China from 2010 to 2020 as a sample to assess the influence of the severity of global warming on financial risk. Global warming is found to affect financial risk and to have a substantial favorable influence on the amount of financial risk. Global warming also has significant effects on households, enterprises, financial institutions, and governments. There is heterogeneity in the effects of climate variation on financial risk. Global warming will cause a greater accumulation of financial risk in economically developed regions. Additionally, it will lead to financial risks by causing a decline in the incomes of residents, a decline in the profits of enterprises, growth in the number of loans that financial institutions consider to be nonperforming, and a widening of the gap between government revenue and expenditures. All of these effects will have an adverse domino effect on the economy. To reduce the financial risks caused by global warming, countermeasures are being offered to ensure social cohesion, conduct risk stress testing, create risk mitigation instruments, and encourage environmentally responsible development. This paper discusses policies and provides policymakers with recommendations on how to cope with the systematic financial risks induced by climate variation.

Macro Credit Risk Stress Testing in Tanzanian Banking Sector: A Global Vector Autoregressive (GVAR) Approach

ABSTRACT This study conducted a macro credit risk stress testing framework for assessing the impact of global transmissions on Tanzania’s banking sector from Q12006 to Q42020, using the Global Vector Autoregressive Regression (GVAR) model with seven countries. The adoption of the GVAR model enabled us to take into account non-linear relationships, capture business cycle effects and the global interaction. This study focused on assessing the projected responsiveness of Tanzania’s credit risk to shocks originating from domestic, global and foreign variables in relation to USA, China and South Africa. This study found that the global transmissions have an impact on the Tanzanian banking sector, with a significant exposure witnessed from the increase in the crude oil price index. On a domestic level, the results revealed that projected inflation rate shocks have a more responsive impact on banking sector credit risk compared to real GDP growth. In addition, GDP growth shocks from foreign countries have a slight impact on the banking sector compared to exchange rate risk transmission, given the growing global interconnectedness, thus leading to a spillover effect on the banking sector. Conclusively, Tanzania’s banking sector is not invulnerable to domestic, foreign and global shocks, and therefore warrants monitoring to enhance resilience.

СИСТЕМНИЙ ПІДХІД ДО СТРЕС-ТЕСТУВАННЯ БАНКІВСЬКИХ РИЗИКІВ

The article reveals the essence of stress testing as a tool for assessing the reliability and stability of economic and technical systems. Based on a retrospective approach, the evolution of stress testing of banking risks in the world and in Ukraine is systematized. A comparative assessment of the definitions of stress testing of banking risks provided by international financial organizations and the national regulator was carried out, and their common and distinctive features were determined. It is shown that according to the level of stress testing of banking risks, it is divided into macro- and microeconomic, their comparison is made, advantages and disadvantages are determined. The main macro- and microeconomic risk factors recommended by the NBU for stress testing are systematized. The content of the banking risk stress testing system has been formalized, its elements have been identified: purpose, tasks, objects, methods, criteria for the effectiveness of stress testing scenarios, models of their formation, assumptions regarding the level of risk, components of the analysis, basic requirements for implementation, main stages. The main methods of stress testing banking risks and types of predicted losses are summarized, their content and main tools are disclosed. It is shown that the most common method of stress testing is the development of scenarios. Systematized NBU requirements for: development of internal bank documents regarding the organization and procedure of stress testing; to the functioning of the information system regarding risk management and reporting in stressful situations; responsibilities of the Chief Risk Manager in terms of communications with the bank's top management and the use of stress testing results for management decision-making. The directions for improving stress testing are substantiated: taking into account real shocks to the financial system, the speed of the spread of crises between countries, expanding the range of risks that are taken into account when building scenarios; regular and systematic implementation, constant review of methods and shock factors; ensuring proper practical use of results; adjusting strategies and plans to reduce banking risks.

Climate Risk Stress Testing: A Conceptual Review

Climate Risk Stress Testing: A Conceptual Review

Mexico

"Volume 2022 (2022): Issue 359 (Dec 2022): Mexico: Financial Sector Assessment Program-Technical Note on Systemic Risk Analysis and Stress Testing" published on 08 Dec 2022 by International Monetary Fund.

Leveraging Machine Learning for Enhanced Climate Risk Compliance in Financial Institutions

The present study investigates the incorporation of machine learning (ML) technologies in financial institutions to tackle the increasing requirements of climate risk regulatory compliance. With the rising scrutiny from regulatory bodies regarding financial institutions’ climate risk management practices, there is a growing need for sophisticated analytical capabilities to evaluate, forecast, and track climate-related risks effectively. This paper outlines the function of machine learning (ML) in improving the accuracy of climate risk scenario analysis, stress testing, and compliance monitoring. As a result, it enables more knowledgeable decision-making and strategic planning. Combining technical analysis and industry-specific knowledge demonstrates how machine learning applications can go beyond conventional analytical limits. This gives financial institutions a solid framework to navigate the challenges of the changing regulatory environment related to climate risks. The results highlight machine learning (ML) ‘s capacity to optimize compliance procedures and facilitate proactive risk management approaches that align with worldwide sustainability goals.

국내 은행 기업대출에 대한 물리적 리스크 스트레스 테스트

본 연구는 우리나라의 물리적 리스크 증가가 국내 은행 기업대출에 미치는 영향을 스트레스 테스트의 방법을 활용하여 측정하였다. 과거 국내 자연재해로 인한 손실의 주 원인이 태풍, 호우로 인한 강수 피해인 것으로 확인됨에 따라 본고에서 물리적 리스크는 강수 피해로 정의하였다. 강수 피해로 인한 지역별 리스크 수준, 업종별 취약도 및 재해의 강도를 종합적으로 고려하여 물리적 리스크 스트레스 시나리오를 설정하고 국내 은행 기업대출에 대한 영향을 측정하였다. 측정 결과 예상손실 규모는 스트레스 시나리오에 따라 2.6조원에서 51.8조 원까지 발생 가능한 것으로 나타났으며, 이는 국내 은행의 총자본비율이 0.13%p, 2.68%p 감소 가능한 수준을 의미한다. 지역별로는 경남, 전남, 대구가, 업종별로는 기계 운송장비 및 기타제품 제조업, 부동산업, 전기·전자 및 정밀기기 제조업이 대한민국의 물리적 리스크 증가에 상대적으로 더 취약한 것으로 나타났다. 본 연구는 물리적 리스크가 국내 금융권에 미치는 영향에 대해 최초로 시도한 연구로서 학술적 기여 뿐 아니라, 향후 국내 금융권의 기후변화 대응정책 마련을 위해 활용가능성이 크다.