The FSA is now requiring firms to improve their stress testing capability, enhance their capital planning stress testing and by introducing a reverse stress testing requirement for firms.

The FSA’s integrated approach to stress testing consists of three main elements:

Firms’ own stress testing – The FSA expects firms to develop, implement and action a robust and effective stress testing programme which assesses their ability to meet capital and liquidity requirements in stressed conditions, as a key component of effective risk management

FSA stress testing of specific firms – As part of its more intrusive supervisory approach the FSA runs its own stress tests on a periodic basis for a number of firms. This is carried out regularly for specific high impact firms and for other firms as the need arises, to assess their ability to meet minimum specified capital levels throughout a stress period.

Simultaneous system-wide stress testing – This is undertaken by firms using a common scenario for the purposes of specific system-wide analysis for financial stability purposes.

The FSA is taking steps now to strengthen all elements of its stress testing approach although the changes mentioned in this policy statement refer to firms’ own stress testing.

Paul Sharma, FSA director of prudential policy, said: “Stress and scenario testing should be an important element in firms’ planning and risk management processes. These changes send a clear signal to firms’ senior management that they need to engage in building a robust stress testing infrastructure as an important part of effective risk management