Banks of all sizes are facing an increasing push by federal regulators to go beyond historical risk-management efforts in the wake of the U.S. housing market’s collapse and the 2008 financial crisis. They’re being asked to evaluate more thoroughly and to prepare better for worst-case scenarios in the economy and in real estate markets in order to avoid future problems.
The problem is, there’s not a lot of specific guidance from regulators on this additional “stress testing,” which has led to confusion about which banks must do it, how they should test, and how they’ll be graded on their efforts, according to Mike Lubansky of Sageworks, a Raleigh, N.C., company that provides stress testing and credit analysis software.
But Lubansky and other industry players heavily involved in stress testing have some helpful advice about what to expect and how to benefit from the process.
Who's Doing It?
“Conceptually, the bank examiners are looking for everyone to do [stress testing],” said Joseph J. Hill, president and chief executive officer of New York consulting firm CEIS Review. “It’s a matter of the extent to which it might need to be done that changes.”
CEIS, which helps commercial and savings banks conduct loan reviews, hears from a lot of its clients concerned about how to approach stress testing. Portfolio size and the complexity of a bank’s loan portfolio to a large extent determine how thorough or complicated stress testing must be, Hill said.
Bank-related stress testing gained widespread attention in 2009 as regulators required the 19 largest U.S. bank holding companies to undergo stress tests demonstrating their ability to maintain minimum capital requirements, even in the event of extreme economic conditions.
But even before that, in 2006, the FDIC outlined guidance for institutions to conduct stress tests if 100 percent of their total capital was in loans tied to construction, development and other land deals, or if they had commercial real estate loans representing 300 percent or more of their risk-based capital. It reiterated that guidance in 2008 in the wake of the housing market’s tumble and the U.S. financial crisis.
Under the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, FDIC-regulated institutions with more than $10 billion in assets will be required to perform stress testing. Regardless of their size, however, many banks are feeling pressure to test their commercial real estate portfolios amid concerns that more volatility in real estate markets may be ahead, Lubansky said.
For more in-depth information on who must perform stress tests, some of the benefits and challenges financial institutions must face, download the whitepaper titled: Stress Testing: The Who, What, When & Why.