Stress Testing: What is Required from Regulators

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Various regulatory initiatives that followed the onset of the financial crisis called for more stress testing by financial companies. This presentation describes the requirements that relate to US financials.

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  • a U.S. BHC that is owned and controlled by a foreign bank that is an FHC that the Board has determined to be well-capitalized and well-managed will not be required to comply with the Board's capital adequacy guidelines.” E.g., Deutschebank.
  • Annual Company-Run Stress Test Requirements Are Delayed Until Fall of 2013 Fornational banks, savings associations and state non-member banks with average total consolidated assets of less than $50 billion; (no reporting for another year after that)BHCs with average total consolidated assets of less than $50 billion U.S.-domiciled BHC subsidiaries of FBOs relying on SR 01-1 for which implementation begins 2015; andstate member banks with average total consolidated assets greater than $10 billion (other than state member bank subsidiaries of SCAP BHCs).
  • 38,975 separate shocks, benchmarked to 2nd half 2008
  • Reasons given for RST:Outside normal business thinkingExplore hidden vulnerabilitiesChallenge assumptions about threats to business viability
  • Stress Testing: What is Required from Regulators

    1. 1. +Stress Testing: Understanding what is Required fromRegulators in Current and Future Legislation Barry Schachter
    2. 2. + Plan of the Talk Scope of stress testing requirements Who‟s affected and when Requirements under different rules  CCAR  Dodd-Frank  Supervisory Guidance SR 12-7
    3. 3. + Who‟s Subject to Stress Test Rules? Supervisory Guidance (SR 12-7): Financial HCos., Banks, S&Ls >$10 billion assets Dodd-Frank (section 165): Financial HCos., Banks, S&Ls, SIFIs >$10 billion assets CCAR: Bank HCos. >$100 billion assets
    4. 4. + Sorting out CCAR and D-F  Dodd-Frank (Sect. 165)  Annual supervisory stress testing for “SIFIs”, includes Banks>$50B in assets  Annual company-run stress testing for Banks and Financial HCos. >$10B in assets  Semi-annual company-run stress testing if >$50B in assets  Company-run scenarios must include a severely adverse scenario  Minimum of three supervisory scenarios required: Baseline, Adverse, Severely Adverse  Mandates public disclosure of results  CCAR  Annual supervisory severe adverse stress test for large, complex bank HCos., >$100B in assets originally, now >$50B
    5. 5. + Number of Affected Firms as of Q3 2012 120 100 Bank HoldCos > $100B 80 Fin HoldCos >$10B 60 *Fin HoldCos >$50B 40 Banks & S&Ls >$10B 20 SIFIs 0 Categories Source: FFIEC, FDIC, Federal Reserve
    6. 6. + Who‟s In the 2012-2013 Cycle? CCAR 19
    7. 7. + Who‟s In the 2012-2013 Cycle? CapPR 11 Other US BHC‟s >$50B in Assets
    8. 8. + D-F/CCAR Stress Testing Cycle November October 1 January 5 March15 15 Fed & Banks Fed Runs Biggest Public Banks Run Own Tests Banks‟ Reporting Develop Scenarios Analyzes Mid-cycle of Results Scenarios Capital Process
    9. 9. + Stress Test Creation  Supervisory Scenarios begin with economic shocks to 26 (for 2012-2013) macroeconomic variables  The stress test must then translate these into their impact on various categories of income and expense, and  Flow those impacts through to net income on a quarterly basis, which  Combined with forecast changes in the capital account, are used to estimate impact on regulatory capital  Trading books are subject to an instantaneous shock as specified by the supervisor
    10. 10. + Macroeconomic Shocks 2013 Supervisory Scenarios 2012-2013 DJ Total Stock Market 20000 18000 16000 14000 12000 11042.3 10000 8000 7221.7 6000 4000 2000 0
    11. 11. + Severely Adverse – Market Shocks Equity by Geography 0% -15% New Zealand Switzerland United Kingdom Chile Sweden Mexico Philippines Turkey -30% Germany Malaysia Australia Euro Stoxx 50 India United States Poland SouthMSCI EAFE Africa Stoxx Europe 600 South Korea FranceJapan China Hong Kong MSCI World Index Belgium Finland MSCI All Country Canada -45% Denmark Hungary Czech Republic Brazil Taiwan WorldIndex Index Netherlands Indonesia Singapore Israel (ACWI) Greece Argentina MSCI EM Index Italy Norway MSCI EMEA -60% Austria MSCI EM Latin Index Spain America Index Bulgaria -75% Russia IrelandPortugal Ukraine, -84.30% -90%
    12. 12. + From economic shocks to gains and losses  Crucial! Two ways to go: simulation historical relationship See, e.g., CCAR 2012: Methodology and Results for Stress Scenario Projections, Appendix A
    13. 13. + Stress Testing under CCAR & D-F  The details  9 quarter horizon, instantaneous shock for trading books  As-of dates  9/30 (and 3/31) for annual (mid-cycle) tests  Random end-Q4 as-of date for trading books  Implementation decisions  Interpolation, extrapolation, proxying shocks  Bank baseline scenario – adopt supervisory baseline?  Models don‟t work with shocks  Documentation  Must use standard templates  must document and justify deviations
    14. 14. + Disclosure  From banks to the supervisor  FR Y-14M (and 14A and 14Q)  From the supervisor to the public  Details of economic and market shocks  Using both D-F and bank capital plan assumptions, lowest quarterly and end of forecast horizon capital ratios, severe adverse scenario  Using D-F capital plan assumptions, time-aggregated net revenue, loan losses (by type), trading and counterparty credit losses, net income
    15. 15. + Disclosure  From Banks to the public  types of risks included in the stress test;  description of scenarios developed by the company, including key variables used (such as GDP, unemployment rate, housing prices);  description of the methodologies to estimate losses, revenues, and changes in capital; and  aggregate losses, pre-provision net revenue, allowance for loan losses, net income, and pro forma capital levels and capital ratios over the planning horizon under each scenario.
    16. 16. + Reverse Stress Testing  New concept for banks  FSA (UK) leading in requiring this  Regulators like it but are silent on method
    17. 17. + Reverse Stress Testing Defined  “assume a known adverse outcome…  “then deduce the types of events that could lead to such an outcome.” (Federal Reserve Board SR 12- 7, p. 12)  Sounds simple, but…
    18. 18. + Reverse Stress Testing History FSA FSA BIS Principles US Proposed RequirementsCRMPG III for Sound UK banks go Supervisory Rules Formalized 2008-08 Stress Testing live 2011-12 Guidance (CP08/24) (PS09/20) 2009-05 2012-11 2008-12 2010-12
    19. 19. + Reverse Stress Testing Illustration Mirzai & Müller. 2013. On Reverse Stress Testing. Intelligent Risk, 8-11.  Pick critical loss level („CLL‟)  Obtain 30K samples from joint distribution of risk factor returns  Revalue portfolio 30K times  Onlylook at those samples where portfolio loss > CLL By CaitlinJo [CC-BY-3.0 (http://creativecommons.org/licenses/by/3.0)], via Wikimedia Commons
    20. 20. + Reverse Stress Testing Illustration Mirzai & Müller. 2013. On Reverse Stress Testing. Intelligent Risk, 8-11.  Can we find economic meaning in these large loss samples?  First, look for statistical commonalities using k- means clustering  Second, relate cluster behavior to market risk factors through heuristic analysis
    21. 21. + Reverse Stress Testing Illustration Mirzai & Müller. 2013. On Reverse Stress Testing. Intelligent Risk, 8-11.
    22. 22. + Reverse Stress Testing In sum: immature art Recent research collected at www.Gloria-Mundi.com; search on keyword phrase reverse stress.
    23. 23. +
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