In the wake of Corona virus (COVID-19) and especially the impact of this pandemic on the global economy, certainly, there needs to be not only the Operational Resilience planning but the preparedness under Pandemic Stress Testing Scenarios as well by the financial institutions.
In the financial / banking world, there exist various Stress Testing scenarios that are required to be reported to the regulators of the respective country like APRA (AU), FRB (US), PRA (UK), EBA (EU), etc.
Banks / financial entities are required to submit the reports under different Stress Testing scenarios as below:
- Baseline Scenario
- Adverse Scenario
- Severely Adverse Scenarios.
These Scenarios are based on various Macroeconomic Variables (MeVs) like interest rate, employment index, inflation index, GDP, forex rates, housing price, etc.
The stress testing of a bank shows the regulators that how a bank will sustain and how the earnings and capital of a bank are impacted in different scenarios, in response to the fluctuating MeVs ranging from Adverse to worst-case (Severally Adverse) scenarios.
Stress Testing is performed spreading the scenarios anywhere from 5 years to 8 years depicting the Loans and Deposits of a bank and related Interest earnings and expenses. The reports can be presented monthly or on a quarterly basis.
If PANDEMIC is also considered as a scenario then it's nothing different from the scenarios mentioned above that banks are required to report to the regulators.
A bank should submit the impact of Epidemic not only in terms of Stress Testing as far as financials are concerned but also in terms of Operational Resilience that how the BAU (Business as usual) is planned to be carried out in this scenario.
The factors that might need to be considered by banks for the Stress Testing Projections under PANDEMIC scenario may range as follows:
- Concentration risk of counterparties/clients which belong to the medical and aviation industry,
- Drop in the customer earning power due to isolations,
- Interest rates might drop resulting in a huge decrease in revenue,
- Fixed expenses might shoot up for operational lags,
- Credit recovery may be hit due to inoperational markets,
- Share Market fluctuations might impact the NAVs of portfolios.
Non-financial risks that might impact the bank may be as follows:
- Key stakeholders may not be readily available for major decisions,
- Key systems might be lagged,
- Cyber attacks can emerge in the absence of resilience security.
Recently, PRA (UK) released guidance on the inclusion of "Climate Change" as a Stress Testing Scenario for the Banks.
Similarly, the regulators should also include the "Pandemic Stress Testing" as well in the reporting requirements.