Scenario Analysis Part 1: Perspectives and Principles

You can use scenario analysis as both a capital estimation and a risk management tool.

Basel II, Pillar 1, identifies scenario analysis as one of the four key elements in estimating minimum capital requirements. Learn about the Advanced Measurement Approaches Group's (AMAG's) six positions on scenario analysis.

  1. Scenario analysis is an important and valuable tool for the management and measurement of operational risk.
  2. An effective scenario analysis process must be tailored to your institution’s business structure, risk appetite, culture, and risk management.
  3. To be credible, the scenario analysis process must meet standards and rigor commensurate with its use.
  4. Your institution must have flexibility to use scenario analysis in a manner that produces maximum cost effective risk management and measurement benefits.
  5. Challenges persist in implementing scenario analysis, but should diminish in time given broad application and continued experimentation.
  6. It would be premature to force a convergence of scenario analysis practices at this time.

This white paper walks you through an overview of the stress testing process and the role of scenario analysis in helping you consider possible future events and outcomes. It is essential for all banks to gain an understanding of this process to consistently measure changing risks.