It is little surprise that capital planning receives renewed focus in a business environment increasingly moving to enterprise-wide risk management. But to sufficiently assess a firm’s financial wellbeing, some quantifiable measures need to be put in place. Many firms are toying with different versions of ‘stress testing’ to gain a concrete understanding of its risks.

How to implement stress testing
The first step of stress testing is to survey key decision makers about the factors most likely to impact earnings or cause a loss in overall capital. Some common risks are likely to come up, such as credit risk, but it’s important to dig deeper and evaluate the preliminary risks that could lead to major threats. These ‘preliminary risks’ can then serve as Key Risk Indicators and help to prevent major fall-outs down the line.

When no quantitative data is available, qualitative assumptions can be used as part of a ‘reverse stress testing’ technique. In these circumstances, the goal is to work backwards to define a maximum allowable loss before your firm exceeds what it deems to be a hard limit.

Risk assessment is just the start
Once you’re happy that your risk assessment is thorough and complete, you should begin the most important stage of the process: recovery planning. Now you understand the stresses and events making you most vulnerable, it’s time to outline how you’ll address problems if and when they arise. There should be a recovery scenario for each and every risk you identify.

Recovery scenarios include:
- Key roles and responsibilities
- Primary actions taken
- Reporting and communication protocols

While stress testing and recovery scenario planning can seem tedious at first, the process will become easier over time and help you to embrace investments, recruitment and major decisions with greater certainty.

Source : Graydon.co.uk

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