Guidelines on the Enhancement of Stress Testing in the CARP for Bermuda's Banking Sector (April 2014)

Summary

This is Bermuda Monetary Authority guidance from April 2014 that enhances the stress testing component of the Capital Assessment and Risk Profile (CARP) framework for licensed banks. It builds on the Authority's 2010 stress testing guidance and the Basel Committee's sound practice principles, integrating stress test results more directly into Pillar II capital add-on decisions.

• Frequency and scope: Banks must run stress tests at least annually, appropriate to their risk profile and risk appetite, and are expected to embed stress testing into risk management more frequently than the annual CARP submission.
• Scenario design: Scenarios must be plausible but severe, bank-wide and comprehensive (consolidated and unconsolidated), covering balance sheet and off-balance sheet exposures, with defensible assumptions for PD, LGD and EL.
• Property and Bermuda-specific risk: Banks must assess the impact of a persistent decline in commercial and residential real estate prices, flat/declining rental income, elevated unemployment and expatriate outflows, and downturns in Bermuda's international business sector.
• Investment book and interest rate risk: Banks must stress test the investment book (credit spreads, yield curve shifts, rating migrations, jump to default) and interest rate risk, with the Authority applying a 200 basis point yield curve shock as a supervisory baseline.
• Projections: Banks must provide pre- and post-stress regulatory capital projections for at least two years forward, assuming an instantaneous shock materialising within the current fiscal year.
• Governance: Boards and senior management must actively set stress testing objectives, challenge scenarios and results, and ensure outputs influence strategic and capital planning decisions.
• Capital deficit response: A capital deficit is assessed against a 7 percent Common Equity Tier 1 (CET1) to risk-weighted-assets ratio under stressed conditions; if breached, banks must implement documented remedial action plans with specified timeframes and provide additional financial projections for a minimum of three years forward.

The guidance also includes a suggested standardised stress test (Appendix I) treated as a regulatory minimum, and supervisory macroeconomic shock assumptions (Appendix II), such as a 30 percent real estate price decline, 12 percent unemployment, 35 percent rental income decline and 25 percent tourism revenue drop, for use in scenario calibration.

Key obligations

• Banks must undertake stress tests at least annually, appropriate to their risk profile and approved risk appetite
• Banks must develop, disclose and be ready to defend the rationale for their stress test assumptions
• Banks must provide pre- and post-stress test regulatory capital projections for at least two years forward, assuming instantaneous loss impact within the current fiscal year
• Banks must stress test property/real estate exposures considering persistent price declines, rental income drops and unemployment/expatriate outflow effects
• Banks must stress test their investment book (credit spreads, yield curve shifts, rating migrations, jump-to-default) and interest rate risk, including sensitivity to a 200 basis point yield curve shock
• Where stress test results fall outside risk tolerance or reveal a capital deficit (CET1 ratio below 7 percent under stress), banks must formulate and document a remedial response with specified timeframes acceptable to the Authority
• Where a capital deficit is indicated, banks must provide additional financial projections (CET1, regulatory capital, RWA, retained earnings) for a minimum of three years forward
• Banks must embed stress testing into their risk management programme and perform it more frequently than the annual CARP submission
• Banks must include the content of their annual stress testing and capital assessment in their CARP submission to the Authority

Applies to

banks (Bermuda's banking sector)

Deadlines

• at least annually: Banks must undertake stress tests at least once a year
• at least two years forward: Required minimum horizon for pre- and post-stress regulatory capital projections
• minimum of three years forward: Additional financial projections required if the stress test exercise results in a capital deficit