Regulators put out for comment proposal on what mid-sized banks should expect from stress tests.
One of the many complaints about Dodd-Frank-era bank stress tests over the past several years was that because regulators have been so unclear about the rules, banks needed consultants to help interpret them. This added cost and heartburn to bankers, who felt the models too mercurial.
However, for mid-size banks – those under $50bn – that will change soon. That’s because bank regulators at the end of July proposed guidance “describing supervisory expectations for stress tests.” Regulators will also “where appropriate” provide examples of “practices that would be consistent with those expectations.”
While bearing the brunt of criticism and rules from regulators, much larger banks have always had the resources to deal with the rules, even while they loudly protested them. And notably for them, stress test requirements have already reached a level of stability (they’ve had the Comprehensive Capital Analysis and Review, CCAR); but not so for their mid-sized peers. Up to now, banks under $50bn received little guidance on requirements to develop their template approach. Uncertainty around the rules for these banks has been bonanza for consulting companies.
But now the Federal Reserve, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency are proposing guidance to provide additional details tailored just for mud-sized banks. The purpose to “help these companies conduct stress tests appropriately scaled to their size, complexity, risk profile, business mix, and market footprint. That’s a far cry from the often fly-blind approach these banks have been using – and not that well, according to some. According to comments heard at the NeuGroup’s Bank Treasurers’ Peer Group meeting in May, the message making the rounds – ostensibly from banking supervisors – is that it is important to get the arithmetic right; this suggests there were math errors in the last go-round of stress tests.
While the guidance has been lacking up to now, mid-sized banks haven’t been sitting idly. Many have been using their stress-test prep to shore up their capital planning. One BTPG member is using the time to optimize its capital structure and reduce the cost of capital required to meet regulatory requirements. And many others are planning the same thing. That’s because capital plans will have to be tied to stress-testing outcomes. This will force many banks to restructure their capital planning processes, starting with the fact that they must estimate the potential impact on regulatory capital of any planned capital actions over the a nine-quarter planning horizon.
The new guidance should help them in that planning.