Recently, the Federal Reserve announced their Comprehensive Capital Analysis and Review (CCAR) stress testing results, with
Having the right technology and process in place to join the credit teams with the financial teams (which can often be like mixing oil and vinegar) in order to understand their portfolios might have prevented this undesired outcome. More banks need to have the ability to quickly execute and synthesize “what-if” results to be in a better position to defend their capital plans. With a well-integrated process enabled through technology, financial institutions can help ensure that they have a robust, forward-looking capital planning process to account for their unique risks, ultimately turning stress testing from a compliance standard to a competitive advantage.
The chart below displays a breakdown of the total losses projected by the top 18 banks under the adverse stress testing scenario. As shown, 50% of the losses are mortgage related (taking out security losses / credit cards / trading and counterparty losses / other losses). Mortgages have complex repayment terms with embedded optionality, and, outside of plain vanilla loans, can be very challenging to predict future performance, let alone for stress scenarios that have not historically taken place. As such, focusing on the process for understanding these mortgage related losses is key.
In speaking with financial institutions in the mortgage credit space, some stated in 2007 “if HPI declines by 10% in two consecutive years that we would all be looking for new jobs.” It’s interesting to see that after that scenario has practically taken place how the Federal Regulators have responded to support the financial institutions, in being more sound and sturdy, by managing their capital planning with more transparency (Dodd-Frank). The regulators are now involved in the capital planning process to the extent that they can now allow or reject a bank to issue dividend payments or share repurchases (buybacks). Given this increased scrutiny, banks need to be operationally ready to handle these demands.
So what options are financial institutions faced with to improve this operational readiness? Here are three steps for how a bank can pass the CCAR and get a holistic view of their portfolio:
1) Join the perspectives of Accounting and Credit/Risk in one centralized platform with a robust process to know the current financial position of the portfolio—“the Holy Grail." Creating a single source of data, reporting, and understanding.
2) Leverage this technology to generate "what-if" scenarios to understand the impact on credit given macroeconomic changes. Institutions should not be afraid to run adversely stressed scenarios to manage the business with better insight even though the scenario has not historically taken place.
3) Execute this technology to have results turned around in a manner of hours, not days. More time should be spent analyzing the results with less time setting up executions in a controlled, automated, repeatable process allowing a bank to manage their portfolio better to make informed decisions.
Banks need to have the ability to quickly adjust macroeconomic changes to their portfolio to understand and anticipate their credit exposures. With some prescriptive technology for operational readiness they can mend their portfolios and turn stress testing into a positive experience.
