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FRM Part II · FRM Exam Part II · Stress Testing Banks

Which feature best distinguishes the supervisory severely adverse scenario used in US regulatory stress tests from a baseline scenario?

The severely adverse scenario is a hypothetical, severe but plausible recession set by supervisors, featuring sharp declines in output and asset prices and higher unemployment. It is designed to test capital resilience, whereas the baseline is closer to an expected economic path and is not a forecast of stress.

  1. AIt depicts a severe but plausible recession with sharp falls in output, asset prices and rising unemployment, designed to test capital resilienceCorrect
  2. BIt is a forecast of the most likely economic path over the next nine quarters
  3. CIt is chosen by each bank to reflect its own business model
  4. DIt includes only market shocks and no macroeconomic variables

Explanation

The severely adverse scenario is a hypothetical, severe but plausible downturn set by the supervisor, not a forecast. The baseline resembles consensus expectations. Banks do not choose it, and it includes macroeconomic variables such as GDP, unemployment and house prices.

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