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

When designing a counterparty credit risk stress testing program, which practice best supports its use in risk management decision-making rather than as a mere compliance exercise?

Stress testing supports decisions when senior management reviews the scenarios and results and the findings drive actions such as limits, hedging, and capital planning. Static, narrow, or model-convenient scenarios turn the exercise into a compliance task that may miss real vulnerabilities.

  1. ARunning the same scenarios annually to ensure comparability, without senior review
  2. BHaving scenarios and results reviewed by senior management, with outcomes linked to limits, hedging and capital planningCorrect
  3. CRestricting tests to the largest ten counterparties regardless of portfolio structure
  4. DUsing only scenarios that the bank's models can easily calculate

Explanation

Stress tests are useful when senior management engages with the scenarios and results and when findings feed actions such as limit setting, hedging or capital planning. Static scenarios, narrow coverage, or model convenience reduce relevance and may hide vulnerabilities.

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