Three federal bank regulatory agencies (the Federal Reserve, the FDIC and the Comptroller of the Currency) issued a press release regarding final guidance describing supervisory expectations for annual stress tests. Financial institutions with total assets of $10 – $50 billion are required to conduct the stress tests annually under rules issued pursuant to Dodd-Frank Wall Street Reform (Section 165(i)(2)) and Consumer Protection Act. These firms are required to perform their first stress tests under the Dodd-Frank Act by March 31, 2014.
The final Guidance for Medium-Size Banks is outlined as follows:[list line=”no” style=”style3″]
- Stress Test Timelines
- Scenarios for Stress Tests : Medium-Size Banks must assess the potential impact of a minimum of three macroeconomic scenarios—baseline, adverse, and severely adverse—on their consolidated losses, revenues, balance sheet (including risk-weighted assets), and capital.The Federal Agencies will provide a description of any additional scenarios no later than Nov. 15 each calendar year.
- Stress Test Methodologies and Practices : In conducting a stress test, Medium-Size Banks must estimate loss projections, PPNR, balance sheet and risk-weighted asset projections, estimates for immaterial portfolios, projections for quarterly provisions and ending allowance for loans and lease losses, and projections for quarterly net income for each scenario. Stress test methodologies and key practices should be commensurate with the bank’s size, complexity and sophistication. Key practices for stress tests include the appropriate use of data sources, data segmentation and model risk management. Medium-Size Banks may use partially validated risk models, provided that such banks have (1) made an effort to identify models based on materiality and highest risk and to prioritize validation activities accordingly; (2) applied compensating controls so that the output from models that are not validated or are only partially validated are not treated the same as the output from fully validated models; and (3) clearly documented such cases and made them transparent in reports to model users, senior management and other relevant parties.
- Estimating the Potential Impact on Regulatory Capital Levels and Capital Ratios
- Controls, Oversight and Documentation : Senior management must establish and maintain a system of controls, oversight and documentation, including policies and procedures designed to ensure that its stress-testing processes comply with Dodd-Frank requirements. Board of directors or a committee must then review and approve the stress-testing policies and procedures processes. In addition, the board of directors and senior management must receive a summary of the results of the stress test. The board of directors and senior management must consider the results of the stress test in the normal course of business and as part of the bank’s ongoing capital planning, assessment of capital adequacy and risk management practices.
- Report to Supervisors : Medium-Size Banks must report the results of the stress test to the appropriate Federal Agencies by March 31 of each year.
- Public Disclosure of Stress Tests : Medium-Size Banks must also publicly disclose a summary of the results of the stress test in the period beginning on June 15 and ending on June 30 of each year. A summary of the stress test results should also be included on the bank’s website.
The agencies’ stress test rules are flexible to accommodate different risk profiles, sizes, business mixes, market footprints, and complexity for companies in the $10 billion to $50 billion asset range. Consistent with this flexibility, the final guidance describes general supervisory expectations for these companies’ Dodd-Frank Act stress tests, and, where appropriate, provides examples of practices that would be consistent with those expectations.
The final guidance from the Federal Reserve Board, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency is similar to proposed guidance issued by the agencies last year. The agencies clarified certain aspects in response to comments received.