Global Banks Urged To Toughen Up Their Stress-testing

Sydney Morning Herald

Monday January 19, 2009

Eric Johnston

GLOBAL banks failed to take into account the interconnected nature of risks when they "stress-tested" lending books, nor did boards play a big enough role in reviewing exposures.

In an assessment of banking shortfalls, the Bank of International Settlements - known as the central bank to the world's central banks - revealed weaknesses in organisational aspects of stress-testing programs.

Global banks, particularly in Britain and the US, have been caught out by the extent of the financial crisis, with new estimates putting potential losses at more than US$1 trillion ($1.49 trillion) following the unwinding of debt instruments.

The US president-elect, Barack Obama, is expected to consider sweeping efforts to tackle the US banking crisis, including the possibility of a new plan that would remove toxic assets from bank balance sheets.

The BIS called on banks to ramp up the shock-testing across their operations.

"Prior to the crisis, stress-testing at some banks was performed mainly as an isolated exercise by the risk function with little interaction with business areas. This meant that, amongst other things, business areas (of banks) often believed that the analysis was not credible," the BIS said in a consultation document about stress-testing balance sheets.

"Moreover, at some banks, the stress-testing program was a mechanical exercise. While there is room for routinely operated stress tests within a comprehensive stress testing program, they do not provide a complete picture," it said.

In Australia, regulators, including the Reserve Bank of Australia, have said the nation's financial system remains sound, and has coped better with the recent turmoil than many other financial systems.

"The banking system is soundly capitalised, it has only limited exposure to subprime-related assets, and it continues to record strong profitability and has low levels of problem loans," the Reserve said in a recent assessment.

National Australia Bank had been most heavily burnt by the global financial crisis after it was forced to make some $1 billion in write-downs on asset-backed securities linked to the US housing market and sitting in off-balance-sheet vehicles.

Elsewhere, ANZ was forced to sharply ramp up provisions and bad debt charges this year, partly as a result of its exposure to corporate bonds backed by troubled monoline insurers.

In a series of recommendations, BIS said stress-testing of a bank balance sheet should begin at board level.

"Stress testing should be actionable, with the results from stress-testing analyses impacting decision-making at the appropriate management level, including strategic business decisions of the board and senior management," it said.

It should also be geared towards the most material business areas and towards events that might be particularly damaging for the firm.

"This could include not only events that inflict large losses but which subsequently cause damage to the bank's reputation," the BIS said in its paper.

© 2009 Sydney Morning Herald

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