Banking regulators including the Federal Reserve and the Office of the Comptroller of the Currency (OCC) recently released the economic and financial market scenarios for covered institutions to use in upcoming stress tests. Institutions required to follow Dodd-Frank Act Stress-Test (DFAST)-level stress tests include financial institutions with total assets of at least $250 billion. This covers only the 34 largest institutions in the U.S.
However, community financial institutions can incorporate the new scenarios for their own stress tests to help determine how their capital levels will fare in severe economic situations.
Why smaller institutions stress test
Despite the total assets threshold noted above, regulators continue to emphasize that all banking organizations regardless of size should have the capacity to analyze the potential impact of adverse outcomes on their financial condition. Agencies note that existing guidance, including that covering interest rate risk management, commercial real estate concentrations, and funding and liquidity management (among others), continues to apply. In addition, given increased volatility in the commercial real estate landscape, financial institutions should expect continued scrutiny surrounding CRE portfolios.
Regardless of regulatory pressure, measuring and managing key risks are the cornerstone of community financial institutions’ enterprise risk management (ERM) programs. Prudent stress testing as a risk management tool helps the enterprise see where the potential pitfalls are in their plans. Banks and credit unions must be able to adjust when necessary to ensure viability of the institution and the ability to supply capital to their local economy. In other words, financial institutions conduct stress testing not only to mitigate financial institution risk but also to provide the board and management with key decision-making information on capital allocation and other decisions that drive achievement of long-term goals.
The 2022 stress test scenarios provide a blueprint for community banks and credit unions to get started on their own stress tests. Banks and credit unions can tailor them to their own instances rather than building them from the ground up – editing the regulator-developed scenarios as opposed to creating them from scratch.