scenario analysis and stress testing for community banks
DESCRIPTION
Description, benefits, and tips on stress testing in banking. Stress testing is a fundamentally sound risk management process for financial services. Community bankers need to create scenarios and run their own stress tests to discover threats and opportunities to their banks..TRANSCRIPT
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SCENARIO ANALYSIS & STRESS TESTING FOR COMMUNITY BANKS
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WHAT IS SCENARIO ANALYSIS?
Scenario analysis is the process of analyzing
possible future events by considering alternative
possible outcomes.
Instead of trying to show one exact picture of the future, scenario analysis presents several alternative future
developments.
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WHAT IS STRESS TESTING?
“What if” scenarios that assist an institution in
understanding the potential impact from
unplanned events.
Can include threats such as increased credit losses,
declines in collateral values, illiquid markets, and strains on liquidity.
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HOW WILL STRESS TESTING HELP?
The stress testing program is the intersection within your bank that provides for the integration of business strategy, risk management, and capital planning. This permits you to better see high-risk concentrations and better prepare for contingencies.
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WHO MUST STRESS TEST?
• Banks and federal savings associations with total consolidated assets of more than $10 billion.
• Community banks with high concentrations in commercial real estate.
• Banks wishing to pay a dividend must stress test future income.
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STRESS TESTING GOAL
Identify your bank’s potential
exposure from possible
events that affect capital,
earnings, or liquidity.
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THE STRESS TESTING PROGRAM
Lead by the board and senior
management.
Part of the management risk
outline.
Should start simply and then become
more sophisticated.
Integral part of overall governance
and risk management
strategy.
Helps set risk appetite and
exposure limits.
Feeds into capital, strategic, annual,
and liquidity planning process.
Governed by adequate policies, procedures, and
controls.
Must result in actionable and
informed decisions.
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STRESS TESTING RISK AREAS
• Estimate the likely impact of risk scenarios on: – Capital
– Concentrated loan portfolios
– Liquidity
– Earnings
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• Identifies risk concentrations across various business lines.
• Enables you to better prepare for contingencies.
• Shapes the risk profile of your bank through better understanding of risk.
BENEFITS OF STRESS TESTING
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BENEFITS OF STRESS TESTING (CONT.)
• Promotes discussion about risk that leads to enhanced internal and external risk communication.
• Can and should help your bank identify additional business opportunities.
• Provides a platform to better understand the risks associated with new products.
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STRESS TESTING TIPS
• Regularly schedule stress tests to review the impact of possible adverse events on earnings, capital, and liquidity.
• Create practical and pragmatic scenarios that are believable and vetted internally prior to their implementation.
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STRESS TESTING TIPS (CONT.)
• Stress testing should foster internal debate and challenge prior assumptions.
• Use stress testing to determine if your bank is operating within its risk appetite.
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STRESS TESTING TIPS (CONT.)
• Be prepared for increased expectations as regulators become accustomed to seeing stress tests as part of the overall risk management framework.
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STRESS TESTING TIPS (CONT.)
• Develop a comprehensive stress testing program so that you can demonstrate: – Effective risk management
processes.
– Capital planning and adequacy.
– The ability to pay dividends or repurchase stock.
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STRESS TESTING TIPS (CONT.)
• Stress testing should lead to the bank taking action, e.g.: – Developing
contingency plans.
– Reducing concentrations.
– Determining the appropriate dividend, raising capital.
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MORE INFORMATION ABOUT SCENARIO ANALYSIS AND STRESS TESTING
• Get the free white paper: http://landing.rmahq.org/StressTesting
• Find stress testing courses: http://www.rmahq.org/events-training
• Or learn about the workbooks on implementing scenario analysis and stress testing at your organization:
– Scenario Analysis and Stress Testing for Community Banks: A Basic Guide
– Scenario Analysis and Stress Testing for Community Banks: A Basic Guide (Download; available to RMA members only)
– Risk Appetite and Scenario Analysis & Stress Testing Combo
– Scenario Analysis & Stress Testing and Governance and Policies Workbook Combo
– Risk Appetite and Scenario Analysis & Stress Testing and Governance and Policies Workbook Combo
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