MORNBFI Vol. 1 - Planters Development Bank

APP. Q-4308.12.31complex models should be reviewed atleast once a year, when changes are made,or when a new product or activity isintroduced. Model review could also beprompted when there is a need for themodel to be updated to reflect changes inthe FI or market. The review processshould be performed by an independentgroup as it is considered to be part of therisk control and audit function.The use of vendor models can presentspecial challenges, as vendors often claimproprietary privilege to avoid disclosinginformation about their models. Thus, FIsmay be constrained from performingvalidation procedures related to internallogic, mathematical accuracy and modelassumptions. However, vendors shouldprovide adequate information on how themodels were constructed and validated sothat FIs have reasonable assurances thatthe model works as intended.c. Stress testingThe underlying statistical models usedto measure market risk summarize theexposures that reflect the most probablemarket conditions. Regardless of size andcomplexity of activities, the BSP expectsFIs to supplement their market riskmeasurement models with stress tests.Stress testing are simulations that showhow a portfolio or balance sheet mightperform during extreme events or highlyvolatile markets.Stress testing should be designed toprovide information on the kinds ofconditions under which the FI’s strategiesor positions would be most vulnerable.Thus stress tests must be tailored to therisk characteristics of the FI. Possible stressscenarios might include abrupt changes inthe general level of interest rates, changesin the relationships among key marketrates (i.e., basis risk), changes in the slopeand the shape of the yield curve (i.e., yieldcurve risk), changes in the liquidity of keyfinancial markets, or changes in thevolatility of market rates.In addition, stress scenarios shouldinclude conditions under which keybusiness assumptions and parametersbreak down. The stress testing ofassumptions used for illiquid instrumentsand instruments with uncertain contractualmaturities are particularly critical toachieving an understanding of the FI’s riskprofile. When conducting stress tests,special consideration should be given toinstruments or markets whereconcentrations exist. FIs should consideralso “worst case” scenarios in addition tomore probable events.Further, the BSP will expect FIs withmaterial market risk exposure, particularlyfrom derivatives and/or structured productsto supplement their stress testing with ananalysis of their exposure to“interconnection risk.” While stress testingtypically considers the movement of asingle market factor (e.g., interest rates),interconnection risk considers the linkagesacross markets (e.g., interest rates andforeign exchange rates) and across thevarious categories of risk (e.g., credit, andliquidity risk). For example, stress fromone market may transmit shocks to othermarkets and give rise to otherwisedormant risks, such as liquidity risk.Evaluating interconnected risk involvesassessing the total or aggregate impact ofsingular events.Guidelines for performing stresstesting should be detailed in the riskmanagement policy statement.Management and the board of directorsshould periodically review the design,major assumptions, and the results of suchstress tests to ensure that appropriatecontingency plans are in place.(3) Model output. Reports should beprovided to senior management and theBoard as a basis for making decisions.Report content should be clear andstraightforward, indicating the purpose ofthe model, significant limitations, thequantitative level of risk estimated by theQ RegulationsAppendix Q-43 - Page 12Manual of Regulations for Non-Bank Financial Institutions