Stress Testing of Jamuna Bank Ltd.

Introduction:
Measuring, monitoring and controlling various types of risks are vital for ensuring the health of a financial institution as well as of the whole financial system. Financial institutions around the world are increasingly employing sophisticated techniques for managing risks. Stress Testing is one of such techniques that have been used to determine the reactions of different financial institutions under a set of exceptional, but plausible assumptions through a series of battery of tests. At institutional level, stress testing techniques provide a way to quantify the impact of changes in a number of risk factors on the assets and liabilities portfolio of the institution. In order to further strengthen the countrys financial system, Bangladesh Bank (BB) has also designed a stress testing framework for banks and FIs to proactively manage risks. For this purpose, and to ensure consistency, BB has prepared a Guideline for banks and FIs. This model Guideline initially focuses on Simple Sensitivity and Scenario Analysis. But with the increasing Knowhow and availability of more data this model will undergo further refinement over time. All banks and FIs are advised to carry out the stress test, as per attached guidelines, from the half year ending June 2010. They shall also submit a report in the format to the guidelines, within 45 days of the close of 30 June 2010, along with a soft copy. Banks shall submit their reports to the Department of Offsite Supervision and the FIs shall submit their reports to the Department of Financial Institutions and Markets (DFI&M). Subsequently, the stress test shall be carried out on half yearly basis i.e. on June 30 and December 31 on each year and results shall be submitted to the DOS and DFI&M within 45 days of the close of each half year.

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Stress Testing:
Stress testing is a simulation technique, which are used to determine the reactions of different financial institutions under a set of exceptional, but plausible assumptions through a series of battery of tests. At institutional level, stress testing techniques provide a way to quantify the impact of changes in a number of risk factors on the assets and liabilities portfolio of the institution. For instance, a portfolio stress test makes a rough estimate of the value of portfolio using a set of exceptional but plausible events in abnormal markets. However, one of the limitations of this technique is that stress tests do not account for the probability of occurrence of these exceptional events. For this purpose, other techniques, for example VAR (value at risks) models etc, are used to supplement the stress tests. These tests help in managing risk within a financial institution to ensure optimum allocation of capital across its risk profile.

Methodology and Calibration of Shocks:

provisioning.
The second deals with the negative shift in the NPLs categories and

hence the increase in respective provisioning.

mortgaged collateral.
The fourth deals with the increase of the NPLs in particular 1 or 2

sector i.e. garments & Textiles and the respective provisioning.

Stress Testing of Jamuna Bank Ltd.

The fifth deals with the increase of the NPLs due to default of Top 10

large borrowers and the respective provisioning.

certain percentage of NPLs, the whole capital position of a bank will be wiped out to offset the increased amount of provision due to cover respective loan losses. The forced sale value of the collaterals and tax adjusted impact of the additional required provision (if any) will be calibrated in the CAR for the each scenario under all categories.

Interest Rate Risk: Interest rate risk is the potential that the value of the onbalance sheet and the off-balance sheet positions of the bank/DFI would be negatively affected with the change in the interest rates. The vulnerability of an institution towards the adverse movements of the interest rate can be gauged by using duration GAP analysis. The banks and FIs shall follow the following steps in carrying out the interest rate stress tests: Estimate the market value of all onbalance sheet rate sensitive assets and liabilities of the bank/DFI to arrive at market value of equity. Calculate the durations of each class of asset and the liability of the on balance sheet Portfolio Arrive at the aggregate weighted average duration of assets and liabilities. Calculate the duration GAP by subtracting aggregate duration of liabilities from that of assets.
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Estimate the changes in the economic value of equity due to change in interest rates on Onbalance sheet positions along the three interest rate changes. Calculate surplus/(deficit) on offbalance sheet items under the assumption of three different interest rate changes i.e. 1%, 2%, and 3%. Estimate the impact of the net change (both for onbalance sheet and off balance sheet) in the market value of equity on the capital adequacy ratio (CAR). Market value of the asset or liability shall be assessed by calculating its present value discounted at the prevailing interest rate. The outstanding balances of the assets and Liabilities should be taken along with their respective maturity or repricing period, whichever is earlier. Exchange Rate Risk:

The stress test for exchange rate assesses the impact of change in exchange rate on the value of equity. To assess foreign exchange risk the overall net open position of the bank/FI including the onbalance sheet and offbalance sheet exposures shall be charged by the weightage of 5%, 10% and 15% for minor, moderate and major levels respectively. The overall net open position is measured by aggregating the sum of net short positions or the sum of net long positions; hichever is greater. For example, the bank may have net long position of Tk.500 million in Yen, Euro and USD and the net short position in GBP and Australian dollar of Tk.600 million. The total exposure will be the greater of the two i.e. sum of the short positions of Tk.600 million. The impact of the respective shocks will have to be calibrated in terms of the CAR. The taxadjusted loss if any arising from the shocked position will be
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Stress Testing of Jamuna Bank Ltd.

adjusted from the capital. The revised CAR will then be calculated after adjusting total loss from the riskweighted assets of the bank/FI. Equity Price Risk: The stress test for equity price risk assesses the impact of the fall in the stock market index. Appropriate shocks will have to be absorbed to the respective securities if the current market value of all the on balance sheet and off balance sheet securities listed on the stock exchanges including shares, NIT units, mutual funds etc falls at the rate of 10%, 20% and 40% respectively. The impact of resultant loss will be calibrated in the CAR. Liquidity Risk: The stress test for liquidity risk evaluates the resilience of the banks towards the fall in liquid liabilities. The ratio liquid assets to liquid liabilities shall be calculated before and after the application of shocks by dividing the liquid assets with liquid liabilities. Liquid assets are the assets that are easily turned into cash without the threat of loss. They include cash, balances with Bangladesh Bank and balances with banks, call money lending, lending under repo and investment in government securities. Liquid liabilities include the deposits and the borrowings. Appropriate shocks will have to be absorbed to the liquid liabilities if the current liquidity position falls at the rate of 10%, 20% and 30% respectively. The ratio of liquid assets to liquid liabilities shall be recalculated under each scenario.

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Stress Testing Jamuna Bank Ltd For the year ended on December 31, 2010
Tk. in million Regulatory Capital Risk Weighted Asset (RWA) Capital Adequacy Ratio (CAR) Weighted Average yield on asset (%) Total Assets Duration Gap Tk.6346.02 M Tk.66,839 M 9.49% 9.96% 70753.70 1.38 Tk. 6346.02 M Tk. 66,839 M 9.49% 9.96% 70753.70 1.38 Tk. 6346.02 M Tk. 66,839 M 9.49% 9.96% 70753.70 1.38 Scenario 1

1. Interest Risk Increase in Interest Rate: Scenario2 Scenario 3

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Magnitude of Shock Fall In MVE(On-balance sheet) Net Fall in MVE-(On- balance sheet offbalance sheet) Tax adjusted loss Revised Regulatory Capital Revised Risk Weighted Assets Revised CAR% Fall in CAR(% points)

1% 946.28 946.28 544.11 5802.21 66294.89 8.75% 0.74%

2% 1892.56 1892.56 1088.22 5258.10 65750.78 8% 1.49%

3% 2838.84 2838.84 1632.33 4713.99 65206.67 7.23% 2.26%

2.Exchange Rate Risk Adverse Movement in Exchange Rate : Scenario2 Scenario 3 Scenario 1

Magnitude of Shock Net on balance sheet currency exposure Exchange rate loss Tax adjusted loss=( ER loss*(1-.425)) (i) Total Capital (ii) Revised capital (iii)=(ii)-(i) Risk weighted asset Revised risk weighted asset (iv) Revised CAR (%) (v)= (iii)/(iv)
Capital Adequacy Ratio (CAR)

5% 256.46 12.82 7.37

10% 256.46 25.65 14.75

15% 256.46 38.47 22.12

6339
66,839

6331
66,839

6324
66,839

66,832 9.48%
9.49%

66,824 9.47%
9.49%

66,817 9.46%
9.49%

Fall in CAR (% age points)

0.01%

0.02%

0.03%

3. Credit Risk increase in NPLs : Scenario 1 Scenario 3 Scenario2

Magnitude of Shock Total Loan Total Performing Loan Total NPLs (i) NPLs to Loans (%) Increase in NPLs (i)*Shock

1% 109,099 108,193 906 0.83% 1,082

2% 109,099 108,193 906 0.83% 2,164

3% 109,099 108,193 906 0.83% 3,246 Page 7 of 15

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Increase in Provisions Revised Capital Revised risk weighted assets Revised CAR (%) Fall in CAR (%age points) Revised NPLs Revised NPLs to Loans (%)

1,082 5,264 65,757 8.01% 1.48% 1,987 1.8%

2,164 4,182 102,222 11.92 1.35 6,517 6%

3,246 3,100 101,428 11.23 2.04 7,311 7%

4. Equity price Risk Fall in Stock Prices : Scenario 1 Scenario 3 Scenario2

Total exposure in stock market Fall in stock price @ 10%, 20% & 40% Tax adjusted loss Total Capital Revised Capital Risk weighted assets Revised risk weighted assets Revised CAR Decrease in CAR ( % age points)
5. Liquidity Shock Fall in Liquid Liabilities : Scenario 1 Scenario 3

10% 171.47 17 10
6346.02

20% 171.47 34 20
6346.02

40% 171.47 69 39
6346.02

6336
66,839

6326
66,839

6307
66,839

66829 9.48% 0.01%

66819 9.47% 0.02%

66800 9.44% 0.05%

Scenario2

Liquid Asset(LA) Liquid Liabilities (LL) Liquidity Ratio (%) (LA/LL) Fall in Liquid Liabilities Revised Liquid Assets Revised Liquid Liabilities Revised Liquidity ratio (%)

10% 44,476 52,041 0.85 5204 39272 46837 0.84

20% 44,476 52,041 0.85 10408 34068 41633 0.82

30% 44,476 52,041 0.85 15612 28864 36429 0.79

Capital Adequacy Ratio for Jamuna Bank Ltd for the year 2010: A measure of a bank's capital. It is expressed as a percentage of a bank's risk weighted credit exposures.
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Interest Rate Risk:

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