MENA is offering a new tool: the Financial Crisis Simulation Exercises

June 7, 2010

June 2010 - Can we improve the capacity to deal with potential systemic problems and mitigate potential adverse effects? MNA is offering a new tool: the Financial Crisis Simulation Exercises.

What are the Financial Crisis Simulation Exercises?

Financial Crisis Simulation Exercises –FCSE- are not a new way of doing stress tests in the financial sector. They are rather different. While stress-tests assess the quantitative impact of a single or a series of shocks on the financial soundness of institutions and the financial sector as a whole, FCSEs test the adequacy of the financial sector stability arrangements (laws, regulation, protocols, procedures, systems, database, reporting…) and the way decision makers utilize them to effectively operate while a simulated crisis unfolds.

FCSEs are multistage exercises delivered to various authorities’ offices via simulated e-mails and other information in which the authorities’ responses to specific scenarios can be articulated and evaluated. They are designed to provide the national authorities with an opportunity to test how co-ordination would work in handling a financial crisis. In particular, exercises are designed to test:

  • Information gathering and sharing;
  • Assessment;
  • Co-ordination of decision-making;
  • External communication and press handling;
  • Functioning of legal and institutional frameworks; and
  • Adequacy of current policy design for crisis management.

How are they prepared?

Preparation of the exercises takes usually four to six month. Over this period, the Bank (supported by consultants or not) develops the scenario and materials for the exercise supported by a project team (with members drawn from the participating authorities). Project team members provide data and other information on the national financial system, and on the relevant laws and decision-making processes in their authorities.

A test run of the exercise is conducted to test that the scenario is coherent and materials realistic, and that the exercise would deliver on the identified objectives. A number of improvements can be identified in the test run which are addressed before the actual exercise. In all, ten to twelve staff drawn from across the authorities are directly involved in the preparation of the exercise. Whatever the lessons from the exercise itself, it is worth noting the benefit arising from the involvement of these staff in building and testing the exercise, giving them exposure to crisis management issues and an opportunity to practice the roles that their authorities would have in a crisis. Also, their experience may help to establish the capacity within the national authorities to design and run their own crisis simulation exercises in the future.

Representatives from Ministry of Finance, Central Bank, Capital Market Authorities and Insurance regulator participate in the exercise. Each authority nominates a small team, which generally comprises the head of the authority and the senior management that would be involved in managing a financial crisis. A staff assistant can support each team.

During the exercise, each authority is free to determine how they work within their team to manage the crisis.

The primary focus of the exercise is on the interactions between those representing the four participating authorities. However the exercise also provides an opportunity to test how these authorities would choose to interact with other relevant parties in a crisis such as banks and other market participants, other domestic (and to a lesser extent, international) authorities and the press. A team of role-players represents these non-participating institutions during the exercise, responding to requests for information and questions but also asking their own questions, thus simulating the pressure that there would be in a crisis from the press and others for information and action. During the exercise, staff from the participating authorities and the Bank acts as role-players.

How are they delivered?

The exercise is hosted by one of the national authorities and takes a whole day. The time is broken into three stages to allow the progression of the scenario to be traced in a realistic way from first identification to final resolution of the problem, with each stage representing a day of “scenario time”.

To test co-ordination of information-sharing and decision-making among the authorities, participants from each authority are located in separate rooms. The exercise materials are then delivered via the internet. Each authority has a webpage that is updated continuously with e-mails and wire stories. Via the webpage, participants can send and receive e-mails to the other participating authorities or the role-players representing other organisations.

Participants can also communicate via telephone or meet face-to-face. One advantage of using a website is the ability to record communication between participants and therefore to be able to analyse more effectively what actions are taken during the exercise.

The day after the exercise, debrief meetings are held with participants to discuss the outcome and to gather first impressions on likely learning points. Discussions in the debrief meetings, findings and recommendations are reflected in a report.

What are the lessons learned?

All exercises bring their own findings and recommendations. The most common weaknesses uncovered by the running of these exercises are:

  • Lack of coordination (including information-sharing, decision-making, and external communication).
  • Lack of systemic risk assessment capacities.
  • Weak arrangements for bank resolution.

In all FCSE, the learning-from-mistakes process seems highly appreciated by authorities FCSEs definitely help them improve their capacity to deal with potential systemic problems and thus mitigate the adverse effects of such problems. FCSEs also serve as a diagnostic tool that regulatory and supervisory agencies can use on a regular basis.