Capital management is a crucial activity in times of financial stress – but often what seemed easy when things were going well proves to be much harder when they are not.
Actual stress conditions can robustly explore how effective our tests and planning were, in simulating the problems we face, and the solutions we need, in a crisis. Stress and scenario testing are two key ways to measure the possible impacts of the huge range of risk events, and to understanding the range of options that may be available, and planning their effective use.
Executing all this should be made easier by referring to the Risk Management Framework, but we should be prepared to modify it in the face of a changed reality.
This is especially true of Target Surplus, the first line of defensive capital. The business assumptions may change materially when conditions change, and it is important to be ready. A full understanding of those assumptions, and the underlying philosophy, are critical to confident action in a turbulent environment.
Real-life stress scenarios are the time for cool heads and decisive action. Management and Board must engage closely and communicate effectively as they execute the day-to-day tasks of capital management: measuring capital sources and uses, tracking adequacy against trigger levels, often needing to initiate action and executing steps to reduce demand or increase supply – while still meeting the everyday needs of the business, its customers and its many other stakeholders.
Often capital management actions in a highly-regulated environment take place in close liaison with a prudential supervisor. Staying alert to supervisory attitudes may prove crucial.
Actuaries often have specific training in risk management, alongside the traditional skills in risk measurement. In times of stress they may be called upon to advise clearly and act decisively in a range of ways, to ensure the viability of the institutions they serve, and to support the well-being of their customers.
In the links below, we aim to give some pointers (updated periodically) to potentially useful material in these relevant topic areas:
Risk measurement – uncertainty and financial reporting, modelling, parameter-setting
Capital requirements and the ICAAP – forecasting demand and supply, responses
Target Surplus – what it’s for – how to calculate it – how to manage it
Supervisory approach – attitudes and actions
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