Stress
testing – Challenges and opportunities – View point
Regulation has become key word in the financial
markets in the wake of the great financial crisis of 2008 driven by collapse of
housing markets in United States of the America and Europe. Stress testing (CCAR- Comprehensive capital
analysis and review) has been prescribed by Federal Reserve to maintain certain
minimum capital standards under adverse and severely adverse economic conditions.
This regulation has triggered cascade of changes to processes, systems and also
in some cases have led to creation of new infrastructure at Banks. All of this
leading more expenditure for Banks that are battered by falling ROE (return on
Equity) and higher and cumbersome capital ratios that need to be maintained.
Despite investing efforts to comply with the regulation some banks have failed
to satisfy regulators and have to resubmit their capital plans.
Challenges
More and more banks are realizing this regulation
calls for an unprecedented effort with respect to volume of data to be
collected followed with performing analytical calculations and finally
capturing the evidence through documentation in compliance with federal
regulators. This act has to be performed with coordination between, Risk,
Finance, Business, Internal Audit, Treasury groups. These efforts are creating
huge challenges to senior management in the Bank.
How Banks should respond? At the very outset banks
should acknowledge failing to meet regulation requirements have wider
ramifications on capital actions. These include failure to distribute dividends
and buybacks, capital and liquidity surcharges, potential show stopper for
planned mergers and acquisitions. Given these consequences, banks have to think
stress testing is not an ad hoc regulatory exercise but instead an input to
bank wide strategy areas, risk management, capital allocation and planning,
risk appetite and business unit planning.
Opportunities
Banks should take steps to streamline regulatory implementation
process and capture potential opportunities that will boost its ROE. This will
require banks to focus its efforts around 3 key areas.
Firstly, Data
infrastructure is most critical to a successful stress testing venture.
Most of the banks need to gather information for Market data, Transaction level
information, and Customer information along with Macro Economic data for
generating scenarios to be fed into their loss, revenue and Trading risk
models. This is a gigantic task where coordination between, Data, Technology,
Finance and Risk groups is need. Some banks have systems and processes in place
to perform these tasks and others are still struggling to emerge out of
cumbersome EXCEL worksheet applications. To gain strategic insights, Banks need
to invest into building into a combination of centralization and
decentralization devolving to unit level from current heterogeneous systems.
Secondly, Analytical
Processing Infrastructure is important element in stress testing. This is
most complicated and important area. This element is further classified into
Quantitative methodologies that are needed to process data and transactions on
trading and Banking books with Technology infrastructure.
Thirdly, Business
intelligence and Reporting Infrastructure is another dimension in stress
testing. This area will transform the data and estimates generated in two areas
discussed above into actionable intelligence and reportable data to regulators.
Senior management has to deploy right tools and technologies to leverage the
information generated in the process.
Therefore Banks need to have expertise in each of these areas to
execute the stress testing to attain insights that will be helpful to execute
business strategy and capital planning.
