Stress testing – how often are stress tests run at your bank?
Banks and credit unions recognize that stress testing their loan portfolio is an important step in sound credit-risk management, and that sentiment has been reinforced by regulators for even community-based institutions.
But like other “good for you” activities, with what frequency should an institution perform stress tests?
It’s recognized that this type of analysis requires significant data and time to pull data from several departments, so bank management is pressed to find the frequency that provides value for portfolio management but does not overwhelm credit and technology departments. Institutions investing in a stress testing software may be able to reduce resources put towards data collection and calculation.
Sageworks surveyed community banks and credit unions to gauge current market practice for stress testing. And the results of the survey show most institutions performing stress tests in conjunction with the ALLL and quarter-end reporting.
The results suggest that bank management use stress testing analysis reports to gauge risk in the portfolio and as part of regular strategic planning decisions. What parts of the portfolio pose a threat to the institution’s safety and soundness? In the event of an economic downturn, how would the portfolio fare? What would be the impact to the bank’s financial situation and earnings?
Answers to these questions allow management to make more informed decisions about where to focus or limit portfolio growth, the adequacy of underwriting and loan review processes, concentration limits, capital levels and liquidity risk.
In the same survey, bankers were asked how often these stress results are shared with the institution’s board of directors. The responses to this question were similar to stress testing frequency, suggesting the Board is regularly involved in review of the data. Nonetheless, a few institutions indicated results were not passed to directors and were used internally by management alone.
What reports are being shared to the board? The best stress test reports for senior management include
1. Analysis of the highest risk segments of the portfolio,
2. Weaknesses that might be particular to the institution (e.g., a bank with a significant concentration in the gaming industry might report on how gaming-regulation changes could impact their borrowers’ ability to service debt)
3. Narrative on what the numbers mean and how the institution would respond in stressed scenarios.
These survey questions were part of a broader risk management survey distributed to community banks and credit unions during the first quarter of 2014. Respondents included credit analysts and lenders, as well as C-Suite leaders such as the CCO or Director of Lending. The survey also covered related credit risk topics including underwriting and loan review functions. Access the results