The covid-19 crisis teaches valuable lessons on stress testing and scenario narratives to risk managers worldwide

Alexandra Brunila, Senior Manager:

Enterprise Risk Management hinges on getting the organization to work together in order to identify, assess and manage risks across all business lines and central functions. In order to be successful, communication by means of storytelling is a powerful tool to be used in dialogue with senior management and the board.

A strong scenario narrative when running stress tests is as important as the methods for risk measurement that are applied to the credit and treasury portfolio. The scenario narrative will spark the creativity and holistic thinking that is required for a stress testing program to be successful. The analysis of the impact to the PnL, balance sheet etc. will likely be more prudent in comparison to a testing program constructed solely on macro-economic assumptions or historical distributions.

The Covid-19 outbreak and its severe consequences in terms of health and economic sentiment will likely prepare and strengthen public institutions for future outbreaks. It will also likely be used in the financial industry as a standard scenario for VaR calculations, credit risk stress testing, business continuity and recovery planning for years to come.

As this crisis has shown us, risk management scenarios and plans matter little if they have been generated in organizational silos or don’t consider the broader society or the interconnectedness of our modern world. Financial institutions play vital roles in good times as well as in crises, providing liquidity and funding. Shouldering this responsibility entails enterprise-wide risk management as well as crisis preparedness. This global pandemic will have lessons to teach risk managers worldwide, supplying organizations with the raw material to test business models, operations and risk mitigation strategies.