CCAR and DFAST Stress Testing Survey Insights
from Moody’s –

In 2015 Fed regulators intend to heighten expectations for the largest and most complex Bank Holding Companies . This is not surprising given the fact that these are the BHC’s with the largest potential impact on the U.S. financial system.

With the complexities of regulatory requirements, large banks are anticipating a major increase in their spending on stress testing. They generally estimate $10m per year in operating costs, with an additional technology cost of $30-$50m.

These were just a few of the insights gleaned from a recent survey of 39 CCAR and DFAST banks during roundtable discussions conducted by Moody’s Analytics.

Three major themes emerged from the series of stress testing discussions:

1. Management judgment versus quantitative modeling: There is uncertainty on when to build a model for a process that has traditionally been forecasted using management judgment.

2. Data: There is a pressing need to better manage the data used in the stress tests, including auditing, augmenting, and aggregating that data.

3. Getting more out of the stress testing exercise: With the amount of time, effort, and money being spent on stress testing, banks would clearly like to use the results for multiple purposes. For most banks, stress testing is still about regulatory compliance, rather than improving their business decisions and risk practices.

The larger banks all agreed that it is hard to determine what to do first, given the multiple regulations in multiple jurisdictions.

Improving infrastructure is desired, but the way forward is not always clear. Banks often lack well-defined roadmaps for longer term projects . The time pressure makes it difficult for them to move beyond regulatory compliance and leverage their stress testing investments to help run their businesses.

Priorities for 2015 Stress Testing

• Across 30 different banks, large and small, credit modeling was the top priority for improvement.
• Large and small banks ranked infrastructure, data, and process/workflow as important items.
• Documentation is becoming a top priority. Regulators are asking for more details and clearer explanations.

Fed Wants More Details and Better Documentation
Capital plans and model methodologies still lack detail, noted a member of the Federal Reserve Bank who spoke at the CCAR roundtable.

Most important, the overall emphasis will continue to shift from quantitative stress test results to qualitative capital plans. The Fed anticipates that there will be fewer quantitative failures during next year’s stress testing than qualitative failures, which was also the story in 2014.

Regulators have indicated they would like to see banks use stress testing for other purposes, like risk appetite definition, limits, and general risk management, but banks have indicated there is still a long way to go before they incorporate stress testing into these areas of their business.

In conclusion, Moody’s anticipates that investments in data, modeling, scenario design, and infrastructure will accelerate as banks seek to deliver more efficient and consistent responses to regulators and to maximize returns on their stress testing expenditures.

How has your approach to capital planning changed in light of today’s regulatory and financial environment?

For many years enterprise risk management was more of a concept than a reality. Now all that has changed.

Enterprise risk management programs have been implemented by organisations of all sizes, with Treasury central to this process. The current regulatory environment requires banks to hold capital not just on their current portfolio. Now they are also required to plan capital for the next three years.

Post 2008 Financial Crisis

Banks must now carefully identify the way their businesses, projected revenues, losses, reserves and capital levels will evolve under adverse macroeconomic scenarios. Regulators around the world have consistently increased the level of regulatory capital required.

To be successful, banks need both an infrastructure and a process for identifying businesses that create long-term value. The system must also be equipped to restructure businesses that are inefficiently managed but have growth potential. The data demands of this process are very high – and they straddle the two domains of risk and finance that have traditionally worked independently of each other.

It’s a delicate balancing act – maximizing growth and profitability while managing risk and ensuring compliance with regulatory agencies.

This paper offers banks a capital management approach that involves long-term capital planning and efficient capital allocation. Learn why banks use enterprise stress testing to bridge the domains of risk and finance. Download the PDF paper below …

CAPITAL MANAGEMENT FOR BANKING

Staying on top of CCAR Fed requirements? Contact Harrison, Stone & Associates at 212.687.3030.

A recent abstract using empirical data, various methodologies and relevant news articles by De Nederlandsche Bank concludes that there is “only weak evidence that stress tests after 2009 affected equity returns of large US banks”.

Equity returns were only affected by the disclosure of the stress test results in 2012 and only for non-gap banks, according to their findings.

Stress tests are an important tool for banking supervisors. Thus, it’s important to consider their effects on stock and credit markets.

The Dutch bank’s abstract quantifies the market reactions of US stress tests performed after the start of the financial crisis by considering their effects on stock returns, CDS spreads, systematic risk, and systemic risk.

US stress tests considered are:
1) Supervisory Capital Assessment Program (SCAP) of the 19 largest Bank Holding Companies (BHCs).

2) Comprehensive Capital Analysis and Review (CCAR) program which assesses the capital planning processes and capital adequacy of banks.

3) Dodd-Frank Act Stress Test (DFAST) stems from the Dodd-Frank Act and requires assessing how bank capital levels would fare in stressful scenarios.

Preventing Crisis

The Federal Reserve stress tests are designed to prevent a repeat of the 2008 financial crisis, when the banking system teetered near collapse and the U.S. created a $700 billion taxpayer-funded bailout program. Firms in this year’s tests must describe what would happen to capital ratios, revenue and loss rates on various assets in dire scenarios described by the Fed.

Referring to post-crisis stress tests former Federal Reserve chairman Ben Bernanke stated last year:

“Even outside of a period of crisis, the disclosure of stress test results and assessments provides valuable information to market participants and the public, enhances transparency, and promotes market discipline.”

The Dutch working paper agrees.

“We have concluded that stress tests have produced valuable information for market participants and can play a role in mitigating bank opacity. Our findings indicate that post-crisis stress tests affected the CDS market strongly but had less impact on bank stock returns.”

The researchers add that their findings suggest that stress tests are a useful tool in mitigating risk in stock and credit markets.

Read the whole report here. Click below to download the “Banking Stress Test Effects on Returns and Risks” pdf:

Staying on top of CCAR Fed requirements? Contact Harrison, Stone & Associates at 212.687.3030.

Accenture’s 2016 Compliance Risk Study has uncovered good news and bad news for the compliance risk function.

On the plus side, demand on compliance is growing, both in scale and in complexity. But the increased need has been met with slowed growth in the compliance function’s stature.

To keep pace with demand, the compliance function will need to change. But how?

The Accenture 2016 Compliance Risk Study results point to several trends—as well as a need for the function to offer more tangible, sustainable outcomes.

The Trends. Compliance function at a crossroads.

• Demands on compliance have been rising. As business functions have become more complex, so, too, has the need for compliance support.
• The compliance function’s growth in stature is slowing. Two years ago, more compliance officers were winning seats at the executive table. That trend appears to have stalled.
• When improving operations, compliance organizations should focus on delivering meaningful results in response to more complex expectations … with fewer resources.

Compliance leaders will need to keep making the difficult choices that support delivering excellent risk management services, and keep asserting a leadership role within the business.

Download the Accenture 2016 Compliance Risk Study.

“80% of employee turnover is due to bad hiring decisions.” – The Harvard Business Review.
When it comes to deciding on your recruiting methods and selecting the right candidates, the amount of choices available to you is nothing short of daunting. Unfortunately, making the wrong hiring decision can cost you time and money.

There is a wide disparity about what a wrong hire can cost a company because there are so many variables. But the cost of selecting the wrong person can run into the hundreds of thousands or even millions of dollars, not to mention the potential negative impact to a company’s reputation, morale, and productivity.

Specifically, recruiters have been known to say that a poor hiring decision for a candidate earning $150,000 per year could cost, on average, $375,000, and that expense comes right off the bottom line.

Why Are These Costs So High?
Expenses associated with hiring include interview expenses such as travel, hotel and meals, training and orientation, employment testing, termination costs such as Cobra, unemployment and potential litigation expenses should the candidate decide to sue you for wrongful dismissal, plus relocation costs, and outplacement or career transition costs. But mostly it’s because you need to repeat the entire hiring process to replace the wrong hire, which includes time and expenses.

Why Companies Hire The Wrong Person
Recent surveys show that the top factor leading to a failed hire, aside from performance issues, is a poor skills match. The second most common reason was unclear performance objectives.

“Wrong hiring” often occurs because hiring managers and human resources people confuse the job description with the job criteria. That’s why it’s important to involve those who are actually doing the job in writing the description. Finding the right match requires time and attention to avoid any miscommunication about what’s required to do a successful job.

Making the wrong hiring decision is an expensive choice and may cost you more than you realize, but it is possible to get it done right.