Really understanding yourself is a feature of a number of ancient philosophies. The idea is that it enables you to have more control over your life. And putting yourself to a test helps you understand yourself. The same goes for your business.
Last week, the Bank of England criticised the newer, smaller challenger banks for their stress testing. It said that many of them displayed “an inability to explain assumptions” in their stress test models. The Bank had been reviewing the stress tests of 20 of the fast-growing UK banks and other deposit takers. Part of the problem may be that these banks are largely start-ups and may have little history of their own to go on. However, the BoE’s comment tells you that these banks may not understand their own business that well, and also that they do not really know whether they could withstand a stress or not. It should be remembered that it was banks’ poor understanding of their own risks that played a large part in the 2008 financial crisis.
However, there is an operating model, a successful one that is common in the tech sector, called the Lean Start-Up. The Lean Start-up approach has at its core the testing of assumptions as a company develops. It includes development of a minimum viable product (MVP) which is used to test the key assumptions of a business plan, and is then continuously adapted to get to a successful product that can be launched more widely in the knowledge that its appeal is well understood, and that success is more or less guaranteed.
The Lean approach also includes repeated testing of alternatives, known as A/B tests (also known as champion-challenger), where you suggest a hypothesis such as a change to the way creditworthiness is assessed or how customer collections are made, and then test it on a sample of customers, comparing the results to a control group where no change is made.
Where an organisation has a habit of test-and-learn as in the Lean approach, then stress tests and the assumptions that go with them are just one more feature of the culture. They become an everyday thing, rather than something you have to cobble together to satisfy the Regulator.
Sources: the Financial Times, “The Lean Start-up” – Eric Ries