A look at how stress test shocks are applied to various elements of the profitability analysis to determine their impacts on the profitability of the bank’s loan portfolio.

1 min readAs part of the stress testing procedures of the bank’s Internal Capital Adequacy and Assessment Process (ICAAP) we will be looking at how shocks are applied to various elements of the original profitability analysis to determine their impacts on the profitability of the bank’s loan portfolio.

# Profitability Analysis Stress Test

The profitability will be stress tested by applying shocks to various elements of the profitability analysis as described earlier. The impact on earnings potential is assessed.

Examples of shocks that could be applied are:

Scenario | Description | Additional Remarks/ assumptions | Example of shocks |

1 | Increase in concentration | All other factors remaining constant | Concentration in a particular sector increases by 10% |

2 | Increase in expected classification | All other factors remaining constant | Expected classification of a particular sector increases by 10% |

3 | Increase in expected provision | Assumes a proportionate change in the worst case provision. All other factors remaining constant | Expected provisions of a particular sector increases by 10%. We assume that worst case provision also increases proportionately, subject to a maximum of 100% |

4 | Decrease in IRR | All other factors remaining constant | IRR of a particular sector decreases by 50bps |

5 | Increase in Cost of Funds | All other factors remaining constant | Cost of Funds increases by 50bps |

We have discussed how the profitability analysis is stress tested. In the next post we will be looking at ways to stress test market risk.