Given the non-linearity in yield movements (the risk that risk will change, or in other words, yield volatility being stochastic), as manifested in the episodic volatility phases I showed, banks should also factor in historical stress scenarios. Under these historical stress tests as well, capital allocated to the Treasury function should not get wiped out. 4.
In addition, banks should conduct reverse stress tests, i.e., ask the question as to what kind of G-Sec yield movements, parallel shift at a minimum but ideally also yield-curve steepening, would wipe out the allocated capital? Indeed, such reverse stress tests have been recommended by the Reserve Bank and could become part of Board-level risk discussions.