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FRM Part II · FRM Exam Part II · The Evolution of Stress Testing Counterparty Exposures

A bank's board receives counterparty credit stress test results only as a single aggregate loss number once a year. Which change would best align the bank's governance with sound practice for counterparty stress testing?

The best change is for senior management and the board to regularly review scenarios, assumptions and results and to use them in limit setting and risk appetite. Stress testing must be embedded in decisions, not produced as an annual number or left to the front office.

  1. AHave senior management and the board regularly review scenarios, key assumptions and results, and use them in limit-setting and risk appetite decisionsCorrect
  2. BDelegate all stress testing to the front office so traders can tailor scenarios to their own portfolios
  3. CLimit stress testing to historical scenarios because they are objective and need no judgment
  4. DReport stress results only to regulators to avoid confusing internal decision makers

Explanation

Sound practice requires stress testing to be embedded in governance: senior management and the board should understand scenarios and assumptions and use the results in limits, risk appetite and capital decisions. Delegating to the front office creates conflicts of interest, and restricting reporting to regulators defeats the internal management purpose.

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