AIM67-4:Contrastthestresstestmethodsof theFinancialSupervisory Authority (FME)andSedlabanki,and compare their resultsto the resultant funding gapat Sedlabankifrom the actual shocks.
Comparison ofStress Tests Methods
Theoriginal liquiditystress test,asconducted hythe Financial SupervisoryAuthority
(FME),didnotgiveashockto dieliabilitysideof the balance sheet.However, replicated FMEstress testsdidinjectliabilityshocks,exceptfordepositsfrom customers,whichare
consideredastablesourceoffunding.
Onthe other hand,aliquiditystress testconductedby thecentral bank (Sedlabanki) gaveshocks toshort-term assetsaswellasshort-term liabilities. The recreated stressrest
combinedthe shocksapplied bytheFMEand the central hankinto asingle test.Incaseof the overlapping ofshocks, thelargershockwasapplied.
Another majordifferencein thestress testmethodsof the FMEandthe central bankwas
related totheweights(i.e., magnitudeofshocks).Shocks bodomestic andforeignstock prices, net provision forlosses, and thecurrencyvalue (krona) werethesamein bothstress tests.However,thereisasubstantial differenceintermsof shocktobond prices. The shock given to thebondpricesinthecombinedtestwas seven timeslarger than die shockgivenin the FME test.Another differencewasdie absenceofashock todomestic andforeign loans and advancesin theFMEstresstest,whereas thecomhined testdid inject shocksto these items.
Page194 ©2013 Kaplan,Inc.
CrossReferencetoGARPAssignedReading-OngandCihak
Comparison ofStressTestResults
hi thissection, we presentresultsofstress testson dieliquidityposition ofalargeIcelandic bank.Allnumbers usedin thisexampleareagain hypothetical (inmillionsof krona), however, theexampleshighlight thepercentageof thedifferencesin the resultsof various
stresstests.
BaseCase
LShort-termassets(total) = 4,000
Short-term liabilities (total) - 4,580
Fundinggap
Fundinggapratio
-580 0.87 Short-termliquidassets(total)= 1,710
Short-term liabilities (total) -4,580
Fundinggap Fundinggapratio
-2,870 0.37
Professor'sNote:funding gapratio =short-term assetslshort-term liabilities. The basecase(originalliquidityposition before thecrisis)showsaliquidity shortagewhich intensifieswhen thefocusis ononly liquidassets.Thatis, the banksability tosatisfy depositors7and borrowers1 short-term claims (current liabilities)byredemptionof shortơ
termliquidassets (whichcan be sold relatively easilycompared toothershort-termassets)
deteriorates significantly(Le.,from 0.87 to 0.37).Thatis, the bankcan pay off87aurar (cents) for1 kronaofliabilitywhen all short-termassetsareincluded.However, whenonly liquidassetsareincluded, the bank'sabilityto pay off theliabilityof1 kronafalls toonly 37Icelandaurar.
FMEStress Test
Asdiscussedearlier,the FME testassumed nowithdrawalofcustomerdeposits.Therefore, thefollowingexampleisbasedon tire no-withdrawal assumption.
Short-termassets(total) LShort-termliabilities(total)
Fundinggap Fundinggapratio
= 4,370
=* 1.000 +3,370
4.37 Short-termliquidassets(total) -1,700
LShort-term liabilities(total)
Fundinggap Fundinggap ratio
= 1,000
+700 1.70
hibothcases,thereisan excessofassetsoverliabilities.However,when thefocusisonly
onliquidassets,thefundinggap ratiofallsfrom4.37to1.70,showinga much reduced
©2013Kaplan,Inc. Page 145
Topic67
Cross ReferencetoGARPAssigned Reading—Ongand CLhak
ability (thoughstillexcessofassetsoverliabilities) of the hankto payoffitsobligations by disposingitsassets.
Combined.StressTest
Asdiscussedearlier, thecombined test used both FMEandcentral bankweights(for shocks), butin diecaseofoverlap, thelargershockwasemployed*
Short-termassets (total) Short-term liability(total)
Fundinggap
Fundinggapratio
- = 5,6402.000
+ 3,640 2.82 Short-termliquidassets(total)=2,040
Short-term liabilities (total} =JL!>Q0 +-40 1.02
Fundinggap Fundinggapratio
Thefundinggap, in thecaseof thecombinedtest, justlike theFMEtest,isstill positive;
however, the gap ratios aresignificantlylower (implying more severeshocksandno
assumptionofdeposit stability).
Actual Shocks with Deposit Freeze
Actual shocksgeneratedagiganticimpacton die economy and the financialsystemof Tceknd. There wasahankrun, andnearly40%of thedepositswerewithdrawn. The liquidityposition of die bankwas rapidlydeterioratingand, tocontrolfurther damage,die depositwithdrawalsatforeign branchesweresuspended. Resultsof diestresstestinvolving actual shocks with thedepositfreezearepresentedasfollows.
Short-termassets (total) Short-term liabilities (total}
Fundinggap Fundinggapratio
=3,586
=2.147
+1,439 1.67 Short-term liquidassets(total} = 1,459 Short-termliabilities (total}
Fundinggap Fundinggapratio
=2.147 -688 U.68
In thisexample,there isa liquidity shortage (excessof liabilitiesoverassets)when assessing liquidassets.Foreverykronaofcurrentliability,the bank hasonly68aurarworthof liquidatingassets.
Notice thatfundinggap ratiosarefallingineach successiveliquidity.stress test,indicating thedeterioratingliquidity posidon of the hank withincreasingshocksfrom the FMEstress testtoactual shocks(withadepositfreeze).
©2013Kaplan,Inc.
Page 196
CrossReferencetoGARPAssigned Reading—Ongand Cihak
Actual Shocks
Thefundinggap(excess) followingactual shocksis estimatedas follows:
Short-term assets (total) Short-term liabilities(total)
Fundinggap Fundinggapratio
= 2,884
-357 o.sy Short-term liquidassets(total) =1,167
Short-term liabilities(total) Fundinggap
Fundinggapratio
-2,074 0.36
In bothcases(ail short-termassetsand short-term liquidassets),there Isa fundinggap
(i.e.,liquidity shortage) and thefundinggapratio isless thanone.
Moreover,thefundinggapratioswith actual shocksscenarios are thelowestamongall thestress tests,indicatingdiat thestress testsdidnot takeintocoiisideration die severity andmagnitudeof the real shocks.Consequently,risk managementplansweredeficientin dealingwith theactual shocks.