• Dr. Omran: For the first time in its history, FRA conducted a stress testing and scenario analysis to measure the impact of risks associated with the Corona pandemic on the non-banking financial sector
• Dr. Omran: Stress testing is one of the components of the early warning mechanism to predict crises. It reveals the extent of the financial stability of non-bank financial companies
Dr. Mohammed Omran, FRA’s Chairman announced the completion of the financial stress analysis test, or what is known as stress testing which has lasted for four months since last April. Stress testing measured the extent to which non-bank financial companies endure financial shocks resulting from the economic effects of COVID-19 in terms of the impact on the revenues and liabilities of these institutions, their financial solvency and the size of the risks they face.
FRA’s Chairman said that the results of scenario analysis and stress testing showed the strength and durability of the financial position of non-bank financial companies. He added that stress testing shed light on some things that must be taken into account during the coming period such as: developing business continuity plan , promoting digital transformation in light of social distancing standards and changing the pattern of business performance. In addition, stress-testing results showed the importance of continuous follow-up of some companies which may face risks that affect their capital adequacy.
Dr. Omran pointed out that the Authority conducted stress testing and scenario analysis – for the first time – as a step in the process of implementing one of the most important axes of its comprehensive strategy for developing non-banking financial activities (2018-2022). He added that this pivotal axis focused on building an integrated risk management system, creating an effective early warning mechanism that reveals the financial stability of non-bank financial companies and works on early prediction of crises that may affect the performance of this vital sector which provide financing and protection for the national economy.
In order to achieve the early warning system, the Authority aimed to assist the non-banking financial sector in understanding the emerging risks and how to deal with the current crisis at the level of each company. That is besides stressing on the importance of developing the necessary solutions in order to face the challenges arising from that crisis whether in the short or long term. Also, stress testing helped in assessing the potential losses of the non-banking financial sector in light of the risks arising from the emerging corona virus pandemic and determining whether the emerging financial risks may require a control measure, whether preventive or remedial, for the potential bad impacts.
According to Omran, the Authority was keen to form a clear and complementary vision to measure solvency and capital base of the units operating in the non-banking financial sector which are affected by the emerging risks associated with the precautionary measures to prevent the outbreak of the Coronavirus. In addition, FRA targeted optimistic and reasonable scenarios with full awareness that pessimistic scenarios may be out of the companies’ current reality.
FRA conducted stress testing and scenarios analysis to measure the impact of this pandemic on the non-banking financial sector and to reduce risks associated with it. Also, the Authority took advantage of the most important lessons from the experience of the global financial crisis in 2008-2009 by applying stress testing on financial banking sector after the crisis and succeeded to a large extent in developing mechanisms that address the repercussions of the financial crisis then.
FRA’s Chairman stated that the scope of stress testing include all insurance companies of both types, whether life or property and liability insurance. As for the capital market , the test application included the participation of 10 major asset management companies, which represent 60% of the asset management market. The test was also applied to 80% of real estate financing companies, representing 97% of the volume of activity, 67% of financing leasing companies, representing 85% of the volume of activity, and 60% of factoring companies, representing 88% of the volume of activity. While applying the test to and microfinance companies and institutions included (18) entities distributed between 6 companies and 8 civil institutions of category (A) and 4 civil institutions of category (B) where the market share of these entities altogether is about 85 % of the volume of microfinance activity.
Dr. Omran added that the Authority depend on gradient scenarios models, starting from the basic scenarios, then optimistic and then pessimistic. Scenario models focused on measuring indicators of financial solvency, liquidity, profitability and operational efficiency as a result of the emerging risks associated with the emerging coronavirus pandemic. The structure of the test models differed according to the nature of the activity and taking into account the identification of the most important risk factors affecting the performance of each activity.
In the insurance activity, 6 models were designed for scenarios. The basic scenarios were concerned with measuring the impact of economic risk factors such as interest rates, low stock market indicators, high rates of reinsurers ’default and increased debtors’ transactions. These models were used in addition to the risk factors associated with the insurance activity, such as an increase in the amount of compensation, an increase in the rates of cancellation and liquidation of insurance policies , as well as a decrease in the compensation recovered from reinsurers. The results revealed a low risk level for threatening poor solvency ratios, a modest risk level for the factor of weak liquidity rates, a somewhat acceptable risk level for the factor of profitability and surplus decline, a modest risk level for the threat of weak liquidity rates and regarding low operational efficiency, it was at a moderate level.
In the field of capital market, 9 models scenarios were designed concerned with measuring the impact of risk factors such as the rate of GDP growth, interest rates and inflation rates. The scenarios for these risks ranged between realistic, optimistic and pessimistic assumptions. The results of the scenarios indicated that the change in interest rates at a rate of 100 basis points results in that 90% of companies will not face any risks, while 10% of them may face moderate risks if these rates change into positive. In the event of a negative change, 20% of these companies may face mild risks and 20% may face moderate risks.
In the field of finance (real estate, financial leasing and factoring), 3 scenarios ranging from the main , medium and most pessimistic scenarios have been designed to measure the risk factors affecting solvency and low financial liquidity rates. The results of the scenarios revealed that the financial solvency of financing companies was moderate, while the result of the scenarios related to liquidity rates and financial hardship was acceptable risks to some extent.
In the field of microfinance, 3 scenarios were designed, ranging from the baseline scenario to the average and then the most pessimistic according to the variable. The results of the scenarios showed that weak solvency ratios represented a moderate level of risk. Meanwhile, weak liquidity rates and financial hardship were at the appropriate level of risk and the decline in profitability and surplus indicators was acceptable to some extent. As for the risks related to the decrease in operational efficiency, the decline in the quality of the portfolio and the increase in provisions, the levels of risk were either low or acceptable.
FRA’s Chairman also notes that stress testing final report which is about 100 pages will be published soon on the Authority’s website for further review and analysis.