Explanation:
Stress-test results are important because they are used to inform the board of the institution’s risk appetite and risk profile, as well as its operating and strategic decisions. Stress-test results provide forward-looking assessments and are especially important in decisions regarding capital and liquidity adequacy and capital funding plans. However, boards should view results with some degree of skepticism and should not rely on a single stress-test exercise, but rather supplement it with other tests and quantitative and qualitative information. Stress testing can serve as an early warning sign, especially in nonstress times, allowing the board to take actions that include adjusting capital levels, increasing liquidity, adjusting risks, or engaging in or withdrawing from certain activities.
(Book 4, Module 54.2, LO 54.f)
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Question 58
A firm's risk director is on the agenda at the firm's upcoming board of directors meeting to discuss stress testing. As this is a relatively new concept for the firm, the risk director has been given 15 minutes at the meeting to go over definitions, rationales, and implementation strategies for putting stress testing into place. Which of the following statements related to stress testing will most likely be questioned by the board regarding its accuracy?
A
Stress-test results are important because they are used to inform the board of the institution’s risk appetite and risk profile.
B
Stress-test results provide backward-looking assessments and are especially important in decisions regarding capital and liquidity adequacy and capital funding plans.
C
Stress testing can serve as an early warning sign, especially in nonstress times, allowing the board to take actions that include adjusting capital levels, increasing liquidity, adjusting risks, or engaging in or withdrawing from certain activities.
D
Boards should view results with some degree of skepticism and should not rely on a single stress-test exercise, but rather supplement it with other tests and quantitative and qualitative information.
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