On Thursday, June 9, 2011, the Federal Reserve Board, the Office of the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC) announced that they were seeking comments on their proposed guidance on stress-testing practices at banking organizations with total assets of more than $10 billion.

“The proposed guidance provides an overview of how an organization should develop a structure of stress testing,” outlining general principles for a satisfactory stress testing framework and describes how stress testing should be used at different levels within an organization, the announcement said. The guidance is intended to be consistent with industry and international supervisory standards.

A banking organization's stress testing framework should include a number of functions, including the following, according to the proposal: estimating business line revenues and losses and informing business line strategies; identifying vulnerabilities and assessing their potential impact; assessing capital adequacy and enhancing capital planning; assessing liquidity adequacy and informing contingency funding plans.

 

In addition, several principles should guide the stress testing structure. Among them:

the banking organization's stress testing framework should include exercises that sufficiently capture organization's exposure, activities and risks

the framework should employ multiple, conceptually sound stress testing activities and approaches

the framework should be forward-looking and flexible

the results should be clear, actionable, well-supported and inform decision-making

The proposed guidance also described several stress testing approaches and applications “that a banking organization should strongly consider using within its stress testing framework.” These are: scenario analysis, sensitivity analysis, enterprise-wide testing, and reverse stress-testing. Banking organizations also should regularly stress test their capital and liquidity, given the importance of these to the organization's viability.

 

The stress testing framework should be “subject to strong governance and controls to ensure that the framework is functioning as intended.” That means critically reviewing the elements of the framework, including key assumptions, uncertainties and limitations. In addition, the stress testing framework should not be isolated within the risk management function, but integrated within business lines, capital and asset-liability committees, as well other decision-making areas.

 

The agencies are requesting comments on the proposed guidance, which they expect to publish in the Federal Register by July 29, 2011. Among the areas for which they are looking for insight are these:

What, if any, additional elements or aspects of an effective stress testing framework should be included in the guidance?

What additional approaches and applications of stress testing have been found to be particularly useful aside from those included in the proposed guidance?

What challenges, if any, exist in applying this guidance generally or at particular banking organizations and why?

Are there any terms described by the proposed guidance that require further clarification? If so, how should they be defined?