Reverse stress testing has been advised by the FSA (Financial Services Authority) in the UK who have said that stress testing in UK financial firms is too weak to prevent another Northern Rock crisis. They are advising firms to do “reverse stress tests” to identify high-risk scenarios. The want banks, building societies, investment firms and insurers to consider scenarios that may cause their firms business to become unviable.
Normally ‘stress testing’ refers to something banks do when considering clients, they stress loan rates taking into account potential rate hikes, but they have never been asked to stress test their own business models in the way they are presently being asked to do.
In a consultation paper published yesterday, the FSA said UK firms were still not testing themselves against sufficiently severe scenarios. The proposed changes are intended to better reflect the importance that is attached to robust stress and scenario testing and to clarify the Regulators expectations of firms.