75)Banks should take into account the nature of the bank’s business, activities and vulnerabilities in designing stress scenarios. The scenarios should incorporate the major funding and market liquidity risks to which the bank is exposed. These include risks associated with its business activities, products (including complex financial instruments and off-balance sheet items) and funding sources. The defined scenarios should allow the bank to evaluate the potential adverse impact these factors can have on its liquidity position. Regardless of how strong its current liquidity situation appears to be, a bank should consider the potential impact of severe stress scenarios.
76)Historical data and past experiences in addition to sound judgment should be used in the scenarios. A bank should consider short-term and long term stresses as well as institution-specific and market-wide scenarios and a combination of both in the stress tests scenarios. The stress test scenarios should consider the following:
•A simultaneous drying up of market liquidity in several previously highly liquid markets (inter-bank money markets, non UAE funding markets, securitization).
•Severe constraints in accessing secured and unsecured wholesale funding;
•The run-off of retail funding
•Contingent claims and more specifically, potential draws on committed lines extended to third parties or the bank's subsidiaries, branches or head office and the liquidity absorbed by off-balance activities.
•Severe operational or settlement disruptions affecting one or more payment or settlement systems.
•Take into account the link between reductions in market liquidity and constraints on funding liquidity. This is particularly important for banks with significant market share in, or heavy reliance upon, specific funding markets.
•A bank should also consider the results of stress tests performed for various other risk types and consider possible interactions between liquidity risk and these other types of risk (e.g. capital stress tests).
•Tests should reflect accurate time-frames for the settlement cycles of assets that might be liquidated (i.e. time to receive the sale proceeds).
•If a bank relies upon liquidity outflows from one system to meet obligations in another, it should consider the risk that operational or settlement disruptions might prevent or delay expected flows across systems. This is particularly relevant for firms relying upon intra-group transfers or centralized liquidity management.
•Additional margin calls and collateral requirements.
•The availability of contingent lines extended to the bank.
•The impact of credit rating triggers.
•The access to Central Bank facilities.
•The potential reputational impact when executing contingency /remedial action.
•Estimates of future balance sheet growth.
•A bank should consider the likely behavioral response of other market participants (similar response to market stress might amplify market strain).
•A bank should consider the likely impact of its own behavior on other market participants.
•Where a bank uses a correspondent or custodian to conduct settlement, the analysis should include the impact of those agents restricting their provision of intraday credit.
The scenario design should be subject to regular reviews to ensure that the nature and severity of the tested scenarios remain appropriate and relevant to the bank.