What are the top areas of concern for the next round of stress testing?

What are the top areas of concern for the next round of stress testing?

An egg cracking in a clamp under pressure.

The Center for Financial Professionals’ conducted extensive research with leading industry practitioners to gain an insight as to the critical challenges over the coming 6-12 months. The results of this research will be summarized and demonstrated at the upcoming 5th Annual Stress Testing USA: CCAR & DFAST congress, taking place November 7-8 in NYC.

The research revealed an industry consensus as to the direction a lot of institutions are moving towards, even amidst uncertainty around the future of stress testing. Many were now focusing on moving their CCAR practices towards a more automated process and minimizing the ‘bottleneck’ of workload as institutions moved towards implementation.

We asked 50+ industry experts what their top areas of concern and were for the next round of stress testing, the three main areas highlighted were focused on strategic planning and BAU, the new administration and idiosyncratic scenario design:

Strategic planning featured heavily in the discussions throughout the research, many seem to be pushing towards using the stress testing results to advance their business and using them to drive the company forward with a more objective view. Some of the thoughts across the industry are:

“We have strategic planning, and we have stress testing, right now, these are two entirely separate work streams, but the regulatory guidance has always been that we are not doing this to make you report to us, we’re doing this to make your own internal processes better, and at some point, you are going to have to tell us how your stress testing is going to factor into your strategic planning. This brings up a whole host of issues, both organisational, political, logistical and timing. The big question taking over here is how do you integrate strategic planning and stress testing?”

“Everybody has been trying to do it differently and to different degrees of success, but they definitely have been pushing to trying to figure out, once they make the investment, what is the best way to utilise it for the purposes of day to day management of the business.”

“There is a lot of discussion around doing the analysis, a lot of structuring and setting up models and testing and validating and things like that. There is also discussion on strategic planning or strategic benefits once you get the results, how you incorporate that into your business plan as opposed to just checking the box and crossing the hurdle on the regulatory exercise, how do you really benefit and develop action plans to really improve your business based on what you are doing there? How do you take what you are doing and distil the information across business lines and at the Board level?”

Closely aligned to strategic planning, and often coming hand in hand was a focus around what the future of stress testing looks like, many were trying to forward project in amongst huge regulatory uncertainty. This uncertainty had an impact across all institutions on budget and head count allocation, with many cutting back to minimise exposure if stress tests are to be amended. This raised concern across the industry as many were concerned that the changes were unlikely, and especially unlikely in the short term, therefore are FI’s ready for the next round of stress testing?

“The big question on everyone’s mind is now what? The new regulation that is being passed right now, we should get more clarity on what this means, but there are questions around what the new congress will be doing politically and on the regulatory side, legal teams have highlighted the potential watering down of CCAR, qualitative pass and fails no longer apply, they’re trying to say that stress tests will be run annually and then CCAR will be ever two years with the Fed. It could be DOA, but managing that uncertainty that’s interesting”

“The regulatory landscape, especially if you keep going back to the conversation more about risk management in a changing regulatory environment and the theme of doing it for yourself and owning it internally vs. for the regulator. Because if the regime changes, and changes of what the rules are from the regulator, that’s going to put firms in a position where they need to own it, they can’t rely on the regulator to define it. Firms have to determine internal practice, and taking what they have learned from the regulator and driving that forward, if a firm values risk appetite or stress testing or governance, taking that on your own even if it is no longer required, while things are in flux you have a question on how much should I do, how little and what is optional?”

“Regulatory reform is part of the programs that are being proposed to change, the general feedback is its going to be very difficult to do anything substantial at this stage in terms of changing the current expectations and process, however there may be some tweaks on the margin, so one thought here in the US is maybe eliminate the exercise altogether, and instead of doing it twice a year, do it once and do it officially, so that could be one implication, and then there is also the thinking of changing it to a 2 year framework. It’s very tough to imagine, especially at this point in time of taking place in the very near time”

Finally, an increased focus across CCAR and DFAST institutions shifted towards idiosyncratic scenarios, how to use them and scenario design. Without the security of pre-determined scenarios, many questioned how far to go, where are the lines between too severe and too conservative and how can these be used to identify exposure and incorporate into strategic planning?

“In CCAR/DFAST we are given those scenarios, so now instead you need to find what scenario you want to model, so now the executives and ERM people have to come up with what are we exposed to and putting that into a model and a more objective way of predicting it. It’s a whole different framework and ties into Reg YY which talks about tying your stress tests and your strategy. So, your very first step is assumed in CCAR/DFAST, so how do you determine which scenarios you want to run for your idiosyncratic stress tests?”

“One of the issues we talk about a lot, is a scenario that will hit your bank harder than others, so the question becomes how realistic is your idiosyncratic scenario and does it matter? Areas come from scenario generation group, but you have to agree with regulators that this is not going to happen, but in the middle of a stress scenario it could and defend your model to the regulator. One thing I would be curious to hear about is how are those idiosyncratic scenarios handled in the scenario generation teams, because you are striking that balance of having a scenario that is too easy, that you designed to stress your portfolio, but you can over shoot the other way and create something where literally the world is ending”

“How do you start once you have lost the comfort of the Fed telling you what to do? All banks have different ways of doing it and all of them start with their executive leadership team, all of them have to do strategic planning, so as part of that strategic planning where can things go wrong?”

As a whole, the industry is moving towards strategic integration with stress testing results and using results to drive the business forward, within this comes the outcomes of company specific idiosyncratic scenarios to personalize findings and incorporate into strategy. In amongst potential upheaval from a regulatory perspective, companies are forced to identify what they value as best practice and incorporate into strategy regardless of regulatory requirements.

Hear from senior industry experts to address their insight on the above topics and many more at the Center for Financial Professionals’ 5th Annual Stress Testing USA: CCAR & DFAST Congress, November 7-8, NYC. The event brings together over 250 senior practitioners to review and discuss the challenges over the next year with stress testing.
Visit www.stress-testing-usa.com for all information on agenda, speaker line up, new additions for 2017 and registration information.