Fed details newer and more stringent stress testing requirements

On November 1, the Federal Reserve Board released the 2014 Comprehensive Capital Analysis and Review (CCAR) Summary Instructions and Guidance, detailing stress testing practices for large bank holding companies in the coming year.

For the last four years, 18 bank holding companies have been required to comply with the Comprehensive Capital Analysis and Review. This year 12 additional financial institutions will be subject to CCAR compliance and additional requirements have been added for capital plans.

Consistent with years prior, the Fed included a “severely adverse scenario” that accounts for a deep recession, tumbling stock markets and rapidly increasing unemployment. The scenario includes 28 severely negative variables that would significantly damage bank earnings and capital. These scenarios and stress testing plans allow banks to plan for situations, even in the face of 11.25 percent unemployment and rapidly deteriorating growth, so they can continue lending.

“Baseline” and “adverse” scenarios accounting for less serious economic complications are also outlined.

One aspect of the new 2014 testing procedures mandates that banks submit to the Fed a capital plan detailing how they intend to accommodate the severely adverse, adverse and baseline scenarios. If they are unable to adequately respond to the scenarios, they must submit a plan to mitigate these shortcomings.

The Fed claims that capital planning and testing measures have resulted in a “significant increase” in the capital of banks tested in recent years, citing that the banks under CCAR more than doubled the ratio of Tier I common capital to risk weighted assets from an average of 5.3 percent to 11.1  percent between 2009 and 2013.

For more information on stress testing approaches and methodologies, download the whitepaper Stress Testing: The Who, What, When and Why.