White Paper - Stress Testing in Smaller Financial Institutions

Stress testing and financial modelling are indispensable to the financial sector. They enable financial institutions to develop their risk appetites and tolerances, and policymakers to assess resilience under conditions of stress, both in the short and long term. Since the financial crash of 2008, new regulations have been issued to strengthen financial institutions' holdings of both capital and liquidity via, among other measures, the creation of severe yet plausible stress scenarios modelling a wide range of stress parameters. With these developments have come new challenges, especially affecting regulatory compliance in smaller-to-medium sized financial institutions.

Stress Testing in Smaller Financial Institutions is an examination of these challenges, researched and written by the Catalyst team at Sussex Innovation on behalf of member company KnowCo Ltd. The research team conducted in-depth interviews with CROs, CFOs, CEOs and MDs of smaller-to-medium sized financial institutions, to gain insight into their roles, as well as the requirements and challenges they face. The research was designed to reveal key issues surrounding their approaches to stress testing and financial modelling, as well as the impact of regulation on these. Among the key findings, it is clearly apparent that smaller financial institutions are in need of a proportional solution, that will support them in maintaining and interpreting data to a universally high standard.

Practitioners from smaller financial institutions expressed a high level of mutual trust and expertise, and as such, the results of these interviews placed much emphasis on the need for improved tools and resources, over and above more skilled or better trained people. The clearest problem is due to teams that are under-resourced and overworked. In this environment, the potential disruption caused by implementing new software is a significant barrier. With changing economic circumstances resulting in many budgets being stretched thinner than before, financial institutions are likely to be wary of any unplanned expenses.

Though many are satisfied with their use of spreadsheet applications, research shows that spreadsheets are in general not properly maintained and audited. Additionally, spreadsheets have inherent potential data integrity issues that may be triggered at far lower tolerances, in terms of data volume, than the suppliers of such systems claim. With the advent of governance regimes that impose duties of responsibility on individuals, many ALCO chairs and Board Risk Committee members are increasingly posing the question to senior management: How do I know I can trust these numbers?

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