GSE FEED

Is stress testing good for you? Featured

Mar 14, 2017

By Brian Caplen

Banks should stop complaining about stress testing and start using it to better understand their business models – although, surprisingly, there does not seem to be an off-the-shelf platform to do the job, writes Brian Caplen.

Since the financial crisis, regulators have adopted stress testing with a vengeance.

Having been criticised for failing to spot and prevent the financial crisis, here is the perfect opportunity for them to not only be rigorous but, as important, to be seen to be rigorous.

Resulting headlines about banks failing stress tests are the best press coverage possible for regulators hoping to restore their reputations.

For banks, by contrast, the process has threatened to get out of hand. The scenarios being dreamed up are ever more outlandish, and banks can get bogged down in months of data collection and analysis. By the time one test is finished, the results are already out of date and it’s time to start the process all over again.

Then there are those headlines. Banks failing stress tests might be good for regulators’ reputations, but for the banks themselves it means yet more negative publicity.

But lately banks are starting to see the upside of stress testing. While all the focus so far has been on capital, stress testing can also tell banks a whole lot about their business models, pricing and profits.

This is how one finance industry executive puts it: “Stress testing has evolved where we’re not just thinking about the balance sheet under stress but also the income statement. Historically we’ve been very balance sheet focused and haven’t spent much time thinking about business model risk and I see that as a focus for the future.”

This quote comes from Deloitte’s latest global risk management survey (https://goo.gl/4ZCZ99) and the report notes how some banks are using stress testing for a whole range of purposes beyond simply pleasing the regulator. For example, 37 percent of survey respondents are using the results for pricing products or benefits, and 45 percent for allocating capital. 

Interestingly, 94 percent use them for reporting to senior management and the board which raises the question: how were these senior folks getting this kind of information before stress testing really took off? Clearly, as the financial crisis showed, some board members’ grasp of intricate capital and liquidity issues can fall short.

Yet if banks are going to use stress test results in new ways, we do need to be confident that the stress test process itself is sufficiently robust. In this regard, regulators are switching their focus from capital levels to controls and capabilities around IT, data collection and quality. The Fed’s deputy director for financial stability policy Andreas Lehnert has described this as a move from wartime stress tests conducted immediately post-crisis to peacetime stress tests.

But the Deloitte report states: “There are no off-the-shelf, end-to-end capital stress testing and planning platforms that institutions can employ to integrate the wide variety of required inputs [needed for stress tests].” Really? I thought there was a platform for everything? High time the IT consultants knocked one into shape.

Brian Caplen is the editor of The Banker.

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