FRM Part I · FRM Exam Part I · Stress Testing
A supervisor designs the severely adverse scenario for a regulatory stress test. Which design choice is most consistent with the purpose of such a scenario?
A severely adverse supervisory scenario should be severe but plausible and internally consistent across macroeconomic and financial variables, for example a deep recession with higher unemployment and falling asset prices. This reveals vulnerabilities that mild or single-factor shocks would miss.
- AUse a mild, highly probable recession so that no bank is expected to show capital depletion
- BUse a severe but plausible, internally consistent set of macroeconomic and financial shocks, such as a deep recession with rising unemployment, falling asset prices and market stressCorrect
- CUse only a single-factor shock to the equity index, holding all other variables constant
- DUse the bank's own historical average loss rate as the scenario
Explanation
Supervisory severely adverse scenarios are intended to be severe yet plausible and coherent across macro and financial variables, to test resilience in a deep downturn. Mild scenarios fail to reveal vulnerabilities, single-factor shocks ignore interactions, and average historical losses are not stress.
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