/stress-testing

name: stress-testing
description: >
  Activate for: ICAAP, ILAAP, stress test, capital depletion, reverse stress test,
  ACS (Annual Cyclical Scenario), DFAST, CCAR, BoE stress test, EBA stress test,
  stressed capital ratio, Pillar 2, capital planning, going concern, stressed ECL,
  stressed RWA, stressed NII.
  NOT for: IFRS 9 macroeconomic scenario weighting (use ifrs9-scenarios),
  market risk capital under FRTB (use basel-rwa-market), liquidity stress
  testing for LCR/NSFR purposes (use liquidity-lcr / liquidity-nsfr).
metadata:
  version: "1.0"
  author: "Panaversity — The AI Agent Factory"
  standard: "BCBS Pillar 2 / SREP framework — jurisdiction implementations vary"

ICAAP PURPOSE AND STRUCTURE

The ICAAP (Internal Capital Adequacy Assessment Process) is the bank's own assessment of how much capital it needs given its specific risk profile, strategic plan, and stress scenarios. The regulator uses the ICAAP output to set Pillar 2 requirements.

Required sections:

1. Business model and strategic overview 2. Risk identification — material risks and their capital impact 3. Capital quantification — Pillar 1 and Pillar 2 needs by risk type 4. Stress testing — capital depletion under severe macroeconomic scenarios 5. Capital planning — sources of capital and management actions under stress 6. Capital adequacy conclusion — does the bank hold sufficient capital?

STRESS TEST FRAMEWORK

Scenario Design

Base case: 3-year capital projection under central business plan assumptions. Adverse scenario: Moderate downturn (unemployment +2pp, GDP -1%, HPI -10%). Severe scenario: Deep recession (unemployment +4pp, GDP -4%, HPI -30%). Bank-specific idiosyncratic scenario: scenario tailored to bank's specific vulnerabilities (e.g., CRE concentration stress, single large counterparty default). Reverse stress test: Work backwards — what scenario causes the bank to fail? (Required in UK by PRA; useful management discipline globally)

Capital Depletion Path — Year-by-Year Model

For each scenario year (typically 3 years): Opening CET1 capital (M)

• Pre-tax profit (NII + fee income - operating costs)

• Tax charge (at applicable corporate tax rate)
• Stressed credit losses (IFRS 9 ECL under scenario conditions)
• Dividend / AT1 coupon payments (suspended in Year 1-2 of severe stress)

+/- Other comprehensive income (AFS securities fair value movements) = Closing CET1 capital (M) / Stressed RWA (M) — see RWA inflation below = Stressed CET1 Ratio (%)

RWA Inflation Under Stress

Credit RWA: Increases as Stage 3 NPLs grow (150% risk weight) and downgrades shift exposures to higher risk weight buckets. Typical severe scenario: credit RWA +10-15% Market RWA: Increases as ES/VaR models expand with higher volatility. Typical severe scenario: market RWA +30-50% Operational RWA: Increases as conduct/AML losses feed into Business Indicator. Typical severe scenario: operational RWA +5-10%

Stressed NII

Asset-sensitive banks (more assets than liabilities repricing in 12 months): Benefit from initial rate rise; hurt by subsequent rate fall Liability-sensitive banks (more liabilities than assets repricing): Hurt by initial rate rise; benefit from subsequent rate fall IRRBB (Interest Rate Risk in the Banking Book) stress: typically +/- 200bp parallel shift, +300bp steepening, -200bp flattening. Load jurisdiction overlay for specific IRRBB scenarios required by the relevant regulator.

CAPITAL DEPLETION PATH — TEMPLATE

| Line Item | Base Y1 | Base Y2 | Base Y3 | Severe Y1 | Severe Y2 | Severe Y3 | | ----------------------------- | ------- | ------- | ------- | --------- | --------- | --------- | | Opening CET1 capital (M) | | | | | | | | + Net interest income | | | | | | | | + Non-interest income | | | | | | | | - Operating expenses | | | | | | | | = Pre-provision profit | | | | | | | | - Credit losses (ECL charge) | | | | | | | | - Tax | | | | | | | | - Dividends and AT1 coupons | | | | | | | | +/- OCI movements | | | | | | | | = Closing CET1 capital (M) | | | | | | | | RWA (M) | | | | | | | | **CET1 Ratio (%)** | | | | | | | | Distance to 4.5% minimum (pp) | | | | | | | | Distance to MDA trigger (pp) | | | | | | |

DISTANCE TO REGULATORY TRIGGER

At each stress year-end, calculate: Distance to hard CET1 minimum (4.5%): Stressed CET1 - 4.5% Distance to combined buffer requirement: Stressed CET1 - [4.5% + CCB + CCyB + surcharge] Distance to MDA trigger: Same as combined buffer requirement Going concern test: Is CET1 above 4.5% at all times? If not: plan capital actions.

MANAGEMENT ACTIONS IN STRESS

Permitted in base case, restricted in severe scenario (per regulator instructions):

• Dividend suspension (Year 1-2): Preserves ~1% CET1 annually for typical bank
• Asset disposals: Non-core asset sales raise CET1 but may crystallise losses
• RWA reduction: Pull back on new lending, reducing RWA growth
• Capital issuance: Rights issue, AT1 issuance — available in moderate but not severe stress
• AT1 conversion: CoCos convert to equity at trigger (typically 5.125% or 7% CET1)

Management Action Cr