Various regulatory initiatives that followed the onset of the financial crisis called for more stress testing by financial companies. This presentation describes the requirements that relate to US financials.

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Stress Testing: Understanding what is Required from
Regulators in Current and Future Legislation
Barry Schachter

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Plan of the Talk
Scope of stress testing requirements
Who‟s affected and when
Requirements under different rules
 CCAR
 Dodd-Frank
 Supervisory Guidance SR 12-7

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Who‟s Subject to Stress Test Rules?
Supervisory Guidance (SR 12-7):
Financial HCos., Banks, S&Ls
>$10 billion assets
Dodd-Frank (section 165):
Financial
HCos., Banks, S&Ls, SIFIs
>$10 billion assets
CCAR:
Bank HCos.
>$100 billion assets

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Sorting out CCAR and D-F
 Dodd-Frank (Sect. 165)
 Annual supervisory stress testing for “SIFIs”, includes Banks>$50B
in assets
 Annual company-run stress testing for Banks and Financial HCos.
>$10B in assets
 Semi-annual company-run stress testing if >$50B in assets
 Company-run scenarios must include a severely adverse scenario
 Minimum of three supervisory scenarios required: Baseline,
Adverse, Severely Adverse
 Mandates public disclosure of results
 CCAR
 Annual supervisory severe adverse stress test for large, complex
bank HCos., >$100B in assets originally, now >$50B

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Number of Affected Firms
as of Q3 2012
120
100
Bank HoldCos > $100B
80
Fin HoldCos >$10B
60
*Fin HoldCos >$50B
40
Banks & S&Ls >$10B
20 SIFIs
0
Categories
Source: FFIEC, FDIC, Federal Reserve

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Who‟s In the 2012-2013 Cycle?
CCAR 19

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Who‟s In the 2012-2013 Cycle?
CapPR 11
Other US BHC‟s
>$50B in Assets

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D-F/CCAR Stress Testing Cycle
November
October 1 January 5 March15
15
Fed & Banks Fed Runs Biggest
Public
Banks Run Own Tests Banks‟
Reporting
Develop Scenarios Analyzes Mid-cycle
of Results
Scenarios Capital Process

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Stress Test Creation
 Supervisory Scenarios begin with economic shocks to 26 (for
2012-2013) macroeconomic variables
 The stress test must then translate these into their impact on
various categories of income and expense, and
 Flow those impacts through to net income on a quarterly
basis, which
 Combined with forecast changes in the capital account, are
used to estimate impact on regulatory capital
 Trading books are subject to an instantaneous shock as
specified by the supervisor

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Macroeconomic Shocks 2013
Supervisory Scenarios 2012-2013
DJ Total Stock Market
20000
18000
16000
14000
12000
11042.3
10000
8000
7221.7
6000
4000
2000
0

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Severely Adverse – Market Shocks
Equity by Geography
0%
-15%
New Zealand
Switzerland
United Kingdom Chile
Sweden Mexico Philippines Turkey
-30% Germany Malaysia
Australia Euro Stoxx 50 India
United States Poland SouthMSCI EAFE
Africa
Stoxx Europe 600 South Korea
FranceJapan China
Hong Kong MSCI World
Index
Belgium
Finland MSCI All Country
Canada
-45% Denmark Hungary
Czech Republic Brazil
Taiwan WorldIndex
Index
Netherlands Indonesia
Singapore Israel (ACWI)
Greece Argentina MSCI EM Index
Italy
Norway MSCI EMEA
-60% Austria MSCI EM Latin Index
Spain America Index
Bulgaria
-75% Russia
IrelandPortugal
Ukraine, -84.30%
-90%

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From economic shocks to gains and
losses
 Crucial! Two ways to go:
simulation historical relationship
See, e.g., CCAR 2012: Methodology and Results for Stress Scenario
Projections, Appendix A

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Stress Testing under CCAR & D-F
 The details
 9 quarter horizon, instantaneous shock for trading books
 As-of dates
 9/30 (and 3/31) for annual (mid-cycle) tests
 Random end-Q4 as-of date for trading books
 Implementation decisions
 Interpolation, extrapolation, proxying shocks
 Bank baseline scenario – adopt supervisory baseline?
 Models don‟t work with shocks
 Documentation
 Must use standard templates
 must document and justify deviations

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Disclosure
 From banks to the supervisor
 FR Y-14M (and 14A and 14Q)
 From the supervisor to the public
 Details of economic and market shocks
 Using both D-F and bank capital plan assumptions, lowest quarterly
and end of forecast horizon capital ratios, severe adverse scenario
 Using D-F capital plan assumptions, time-aggregated net
revenue, loan losses (by type), trading and counterparty credit
losses, net income

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Disclosure
 From Banks to the public
 types of risks included in the stress test;
 description of scenarios developed by the company, including
key variables used (such as GDP, unemployment
rate, housing prices);
 description of the methodologies to estimate
losses, revenues, and changes in capital; and
 aggregate losses, pre-provision net revenue, allowance for
loan losses, net income, and pro forma capital levels and
capital ratios over the planning horizon under each scenario.

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Reverse Stress Testing
 New concept for banks
 FSA (UK) leading in requiring this
 Regulators like it but are silent on method

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Reverse Stress Testing Defined
 “assume a known adverse outcome…
 “then deduce the types of events that could lead to
such an outcome.” (Federal Reserve Board SR 12-
7, p. 12)
 Sounds
simple, but…

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Reverse Stress Testing History
FSA FSA
BIS Principles US
Proposed Requirements
CRMPG III for Sound UK banks go Supervisory
Rules Formalized
2008-08 Stress Testing live 2011-12 Guidance
(CP08/24) (PS09/20)
2009-05 2012-11
2008-12 2010-12

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Reverse Stress Testing Illustration
Mirzai & Müller. 2013. On Reverse Stress Testing. Intelligent Risk, 8-11.
 Pick critical loss level
(„CLL‟)
 Obtain 30K samples from
joint distribution of risk
factor returns
 Revalue portfolio 30K times
 Onlylook at those samples
where portfolio loss > CLL
By CaitlinJo [CC-BY-3.0
(http://creativecommons.org/licenses/by/3.0)],
via Wikimedia Commons

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Reverse Stress Testing Illustration
Mirzai & Müller. 2013. On Reverse Stress Testing. Intelligent Risk, 8-11.
 Can we find economic meaning in
these large loss samples?
 First,
look for statistical commonalities using k-
means clustering
 Second, relate cluster behavior to market risk factors
through heuristic analysis

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Reverse Stress Testing Illustration
Mirzai & Müller. 2013. On Reverse Stress Testing. Intelligent Risk, 8-11.

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Reverse Stress Testing
In sum: immature art
Recent research collected at www.Gloria-Mundi.com;
search on keyword phrase reverse stress.

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