95. Institutions should, where appropriate, use sensitivity analyses as a starting point for …

Institutions should, where appropriate, use sensitivity analyses as a starting point for reverse stress testing, e.g. shifting one or more relevant parameters to some extreme to reach pre-defined outcomes. An institution should consider various reverse sensitivity analyses for credit risk (e.g. how many large customers would have to go into default before the loss absorbing capital is lost), market risk, liquidity risk (e.g. stress on deposits in the retail sector and circumstances that would empty the institution’s liquidity reserves) and operational risk, among other risks, and a combination analysis where all risks are covered simultaneously. However, an institution should not primarily use a sensitivity analysis and simple metrics to identify the scenario relevant for the reverse stress test. The qualitative analysis should lead to the identification of the relevant scenario, combining expert judgement from different business areas, as thinking might be the most effective way to prevent a business model failure. A joint stressing of all relevant risk parameters using statistical aspects (e.g. volatility of risk factors consistent with historical observations supplemented with hypothetical but plausible assumptions) should be developed. The plausibility of the parameter shifts required to reach the pre-defined outcome gives a first idea about possible vulnerabilities in the institution. To assess the plausibility, historical (multivariate) probability distributions – adjusted, where deemed necessary, according to expert judgements – should, inter alia, be applied. Qualitative analyses and assessments, combining expert judgements from different business areas, should guide the identification of relevant scenarios.

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