Stress Testing 102

Rise of the PPNR Machines

The financial crisis and subsequent responses have brought about a revolution in stress testing. Banks have invested in capabilities to link macro-economic and market factors to forecasts of key risk parameters, especially traditional ‘Risk’ metrics such as credit losses, trading losses and risk-weighted assets.

Nevertheless, forecasting capabilities for pre-provision net revenue (PPNR) have lagged, and this gap is invariably the most significant shortcoming in banks’ planning and stress testing toolkits across both the banking and trading books. Banks included within the US Federal Reserve’s CCAR and Dodd-Frank Act stress testing regime have begun to develop PPNR capabilities, employing statistical models that borrow from the techniques used for “Risk” stress testing. In this paper, we observe that leading firms globally are importing or replicating these capabilities and should the wide-ranging benefits that an effective PPNR approach can have for their stress testing, strategy development, planning and budgeting.

Stress Testing 102