Avert risk & improve risk rating strategies using stress testing data
By Cathy Moore, Sageworks
The OCC notes that financial institutions that perform stress testing “have the ability to minimize the impact of negative market developments more effectively” than those that do not have a stress testing process in place. What does this mean for bankers?
It means that stress test results can help executives identify the riskiest segments of the portfolio, segments that might be susceptible to short term interest rate fluctuations or the real estate market. By recognizing these risks in advance, bank execs can make accommodations or plans that mitigate potential impact.
Ancin Cooley, principal of Synergy Bank Consulting Inc., also believes stress testing can serve as sort of an advance-warning system. “When properly integrated into a bank’s strategic-planning process and credit culture, stress testing can help community bankers better understand their own risk appetite and can identify concentrations of loans that pose a risk to the bank’s earnings and capital,” he says.
The OCC specifically recommends: “Management can use stress testing to establish and support reasonable risk appetite and tolerances, set concentration limits, adjust strategies and appropriately plan for and maintain adequate capital levels.”
Improve risk rating strategies
First City Bank a $60 million-asset institution in Columbus, Ohio, has been performing bottom up stress testing on their portfolio for over six years. Bank President Charlie Cecil explained that the bank segments their portfolio by filters such as geographic region and product type and then tracks the migration of risk grading by utilizing market data on trends in property values. Appraised values for properties are then adjusted by the amount of average decline in the market. Cecil commented, “These tests have provided us the ability to look at loan migration over time and see how things change from a stress standpoint.”
Like First City Bank, financial institutions can use the results of this type of stress testing to understand potential risk migration and to develop better risk rating strategies. As the 2012 FDIC Supervisory Insights suggests, “Stress-test results for individual loans can be used by loan officers and credit committees to better understand a borrower’s or property’s risk characteristics and position the bank (as lender) for unexpected adverse circumstances.” They can then use this information to update the risk ratings and pricing strategy.
Learn more about stress testing in community banks, download this whitepaper: Actionable Stress Test Results for Community Banks.
Or, learn more about how Sageworks’ top down stress testing solution, Sageworks Stress Testing, can be used to deliver these reports.