Stress testing guidance for mid-sized banks

Bank regulators are giving mid-sized banks ($10 billion to $50 billion in assets) additional guidance and another opportunity to provide feedback on the process of stress testing that these banks must begin this fall.

The FDIC, Federal Reserve and the OCC recently issued proposed supervisory guidance on implementing the stress testing required by the Dodd-Frank Act and said they will accept comments on the joint guidance until Sept. 25.

The proposed guidance fulfills a pledge by the agencies last fall to clarify expectations for mid-sized banks, which will be required to begin stress testing using data from the Sept. 30-ending quarter to make projections for the quarters beginning Dec. 31, 2013, and ending Dec. 31, 2015. Results of these tests must be reported to banking supervisors by March 31, 2014, and financial institutions are required to disclose their first summary of results to the public by June 30, 2015. 

“Of the banks in that $10 billion to $50 billion range, some of them are pretty well prepared for this first year’s stress test, but some of them have been scrambling and are still scrambling to get their models in order to do the stress testing later this year,” said Michael Lubansky, director of consulting services at Sageworks.

In the proposed guidance, the regulators addressed several key areas, including:

Supervisory scenarios. The agency supervising the bank will provide by Nov. 15 a description of the hypothetical macroeconomic scenarios to be used to assess capital strength in baseline and stressed economic and financial conditions. The proposed guidance also indicated that banks aren’t required to use all of the variables provided in the scenario, and companies may use additional variables.

Data sources and segmentation. The proposed guidance describes how companies should segment portfolios and business activities when conducting stress testing.

Pre-provision net revenue estimation. It describes how estimating projected pre-provision net revenue methods can vary, depending on the complexity and sophistication levels of the institution.  

Balance sheet and risk-weighted assets projections. The proposed guidance notes companies should document and explain key underlying assumptions about changes in balances or risk-weighted assets under stressful conditions. This includes justifying any major changes and any assumptions about loss-mitigating strategies under stressful conditions.

The FDIC, Federal Reserve and OCC also said they seek comment on five specific aspects of the proposed guidance. Those aspects include:

The challenges anticipated in relating the scenarios’ national variables to regional and local market footprints.

The clarity needed regarding the appropriate use of historical experience in the loss, revenue, balance sheet and risk-weighted estimation process.

The clarity needed regarding the use of third-party products and services for stress testing.

Details on what might be helpful to clarify regarding the stress testing responsibilities of boards and senior management.

“Generally, this proposed guidance is fairly similar to the guidance that has already been issued,” Lubansky said. “This is the first year [regulators] are asking these banks to do this, so they’re just trying to solidify the guidance a little more.”

The need for guidance on stress testing is clear. In the Sageworks 2013 Bank & Credit Union Examination Survey, a common theme among institutions of all sizes responding was that stress testing is being evaluated and recommended strongly in some safety and soundness examinations and not in others, even when examined by the same regulatory agency. Community banks, in particular, have sought guidance on best practices for stress testing at their level.

“This is supposed to add some clarity and given financial institutions one last chance to comment on the clarified guidance,” Lubansky said.

Read the proposed guidance and find links for offering comments here.

To read more about the data needed for stress testing, download our whitepaper on Solving Data Challenges of Loan Portfolio Stress Testing.