Goldman Sachs 2015 Annual Report Download - page 112

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management’s Discussion and Analysis
Scenario analysis is used to quantify the impact of a
specified event, including how the event impacts multiple
risk factors simultaneously. For example, for sovereign
stress testing we calculate potential direct exposure
associated with our sovereign inventory as well as the
corresponding debt, equity and currency exposures
associated with our non-sovereign inventory that may be
impacted by the sovereign distress. When conducting
scenario analysis, we typically consider a number of
possible outcomes for each scenario, ranging from
moderate to severely adverse market impacts. In addition,
these stress tests are constructed using both historical events
and forward-looking hypothetical scenarios.
Firmwide stress testing combines market, credit,
operational and liquidity risks into a single combined
scenario. Firmwide stress tests are primarily used to assess
capital adequacy as part of our capital planning and stress
testing process; however, we also ensure that firmwide
stress testing is integrated into our risk governance
framework. This includes selecting appropriate scenarios to
use for our capital planning and stress testing process. See
“Equity Capital Management and Regulatory Capital —
Equity Capital Management” above for further
information.
Unlike VaR measures, which have an implied probability
because they are calculated at a specified confidence level,
there is generally no implied probability that our stress test
scenarios will occur. Instead, stress tests are used to model
both moderate and more extreme moves in underlying
market factors. When estimating potential loss, we
generally assume that our positions cannot be reduced or
hedged (although experience demonstrates that we are
generally able to do so).
Stress test scenarios are conducted on a regular basis as part
of our routine risk management process and on an ad hoc
basis in response to market events or concerns. Stress
testing is an important part of our risk management process
because it allows us to quantify our exposure to tail risks,
highlight potential loss concentrations, undertake risk/
reward analysis, and assess and mitigate our risk positions.
Limits. We use risk limits at various levels in the firm
(including firmwide, business and product) to govern risk
appetite by controlling the size of our exposures to market
risk. Limits are set based on VaR and on a range of stress
tests relevant to our exposures. Limits are reviewed
frequently and amended on a permanent or temporary basis
to reflect changing market conditions, business conditions
or tolerance for risk.
The Risk Committee of the Board and the Firmwide Risk
Committee approve market risk limits at firmwide and
business levels and our divisional risk committees set sub-
limits below the approved business-level risk limits. The
purpose of the firmwide limits is to assist senior
management in controlling our overall risk profile. Sub-
limits set the desired maximum amount of exposure that
may be managed by any particular business on a day-to-day
basis without additional levels of senior management
approval, effectively leaving day-to-day decisions to
individual desk managers and traders. Accordingly, sub-
limits are a management tool designed to ensure
appropriate escalation rather than to establish maximum
risk tolerance. Sub-limits also distribute risk among various
businesses in a manner that is consistent with their level of
activity and client demand, taking into account the relative
performance of each area.
Our market risk limits are monitored daily by Market Risk
Management, which is responsible for identifying and
escalating, on a timely basis, instances where limits have
been exceeded. The business-level limits that are set by the
divisional risk committees are subject to the same scrutiny
and limit escalation policy as the firmwide limits.
When a risk limit has been exceeded (e.g., due to changes in
market conditions, such as increased volatilities or changes
in correlations), it is escalated to the appropriate risk
committee and remediated by an inventory reduction and/
or a temporary or permanent increase to the risk limit.
100 Goldman Sachs 2015 Form 10-K