15 Jan Strengthening Stress Testing Processes In 2021 And Beyond: Is The Sun Setting On 2020’s Black Swan Event Or Should We Expect An Incoming Flock?
Throughout Acts One through Four of our series, Stress Testing Processes – How To Manage A Black Swan we have explored the complicated relationship between menacing black swan events and innovative and adaptable stress testing processes. We have concluded, and you may now agree, that although they at first seem to dance the same steps, the swan characters of Odette and Odile from the famous ballet fairytale Swan Lake are not only different, but the latter presents a series of distinct challenges.
Just as this dichotomy of the dueling swans can be daunting for the prince in the fairytale, the consequences of being unprepared for black swan events can be daunting to organizations if they do not have flexible, transparent, and adaptable stress testing processes for their capital-liquidity-risk systems.
From Curtain Up To Encore
In the previous acts of this complicated ballet, we explored the difficulties of predicting which swan will appear amid a backdrop of unpredictable economic factors, unforeseen events, and systemic risks that can throw an organization or even an entire system off kilter. We concluded that organizations must be prepared for many stress testing possibilities and explored various topics:
- In Act One: Stress Testing Scenarios – It’s Stressful Living With A Black Swan we discussed the need for stress testing scenarios, processes, and technologies that financial institutions can leverage to prepare for severe disruptors to capital and liquidity management, as has occurred during this global pandemic black-swan event.
- In Act Two: Liquidity Risk Stress Testing Scenarios – Dealing With Odile, That Villainous Black Swan, we analyzed the complex choreography involved in liquidity risk stress-testing scenarios and explored why big data is good, but ‘small’ data is what you really need for robust liquidity risk management – especially when the villainous black swan Odile is dancing.
- In Act Three: Capital Stress Testing Scenarios And Swan Lake – Taking On The Most Fiendish Of Double Roles, we looked at factors such as changing definitions of default, the role of capital buffers and risk appetite when adjusting models, and important differences between point-in-time (PIT) model inputs versus through-the-cycle (TTC) ones.
- In Act Four: Evolving Stress Testing Scenarios In 2021 – What Happens At the End Of Swan Lake? we asked several questions including, How can organizations fine tune their capital-liquidity-risk systems and processes to more flexibly accommodate flocks of swans and not just isolated fly-ins?
The Covid-19 pandemic’s immediate effect and ongoing aftershocks have shown that a sudden, drastic reduction in global economic activity is entirely possible. This phenomenon was not only unprecedented but unpredicted and it seems that black swan events might be becoming more the norm, not just once in a generation phenomena. Organizations need to be prepared for a full spectrum of stress scenarios. This is even more important now given that the lingering effects of black-swan events could lead to economic uncertainty and volatility for years to come. In other words, black swans could be making way for gray swans.
Fine Tuning The Dance Steps To Be Ready For Anything
While the black swan Odile’s 2020 Covid-19 driven performance may not be everyone’s favorite, it seems unlikely that we will vanquish her forever. The reality is that we must learn how to tame the black swan and be prepared to resist her evil charms by evolving stress testing processes accordingly.
Preparation For Future Unknowns
As we all move into a brave new world of stress testing processes that are ready for anything, decisions made now will contribute to business growth and future-proofed risk architectures.
When financial institutions can adequately assess critical influences on evolving stress testing scenarios, they are able to flexibly adapt their capital, liquidity, and operational stress testing to whatever situation may be at hand. The ability to pivot and adapt ensures they will be prepared for the future, even if Odile magically multiplies and refuses to leave the theater. Capabilities that can address problematic scenarios will be a critical to the success of organizations as they take on current and future black swans.