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Uncertainties loom over next round of US Fed stress tests

Henry Engler  Thomson Reuters Regulatory Intelligence

Henry Engler  Thomson Reuters Regulatory Intelligence

Big U.S. banks have expressed concern over the numerous uncertainties they face ahead of new stress testing exercises from the Federal Reserve later this year. Uncertainties include the severity of the economic downturn banks will need to project as well as amount of data they must submit.

Last month, the Fed released the results of its supervisory stress tests for 2020 and a special “sensitivity analysis” conducted under a range of “plausible downside scenarios” related to the COVID-19 pandemic. At the same time, the Fed said banks will need to reassess their capital needs and resubmit their capital plans as well as conduct additional stress analyses “later this year.”

Just what “later this year” means and type of economic scenarios banks will be required to run through their models was a major concern during a recent webinar hosted by the Securities Industry and Financial Markets Association. In addition, there is worry over the amount of information banks will need to provide, given a shortened 45-day submission period. The Fed used to give banks 60 days in prior exercises.

Will the Fed incorporate a “W” economic scenario?

With a resurgence of COVID-19 in major states such as Texas, Florida and California, there is a rising risk the U.S. economy may be facing another decline in activity later this year, if businesses are forced to shut to slow the virus’s spread. Rather than a traditional “V” or “U-shaped” recession, a so-called “W-shaped” scenario is not something banks are used to incorporating in their models and projections for capital resiliency.

Marc Saidenberg of Ernst & Young said his biggest concern was if the “Fed is contemplating a ‘W’ recession.” Saidenberg, who works with many large firms on stress testing, added that “there is almost no model development to project credibly over a two-trough type of scenario. There are a lot of projection frameworks that are anchored by a decline and followed by a slow and steady recovery.”

Charles von Althann of PWC explained that further complicating the modeling and projection process is the unprecedented economic and financial stimulus provided by the government and Federal Reserve, and the uncertainty over whether such programs will continue. “Firms will need to use variables that reflect the extraordinary actions by government,” von Althann said. “How do you bake that into your models?”

Another uncertainty is the high level of forbearance that banks have shown their customers regarding loans and other forms of credit. It is very unclear to what extent such forbearance will continue. Some analysts see it ending later this year. “How are you going to forecast defaults and get them validated in time for the next submission?” von Althann asked.

Many senior bank executives have noted that consumer and business credit defaults were limited in the second quarter largely by government stimulus programs, making it more difficult to gauge borrowers’ true underlying creditworthiness and financial position.

As-of dates and capital submission requirements

Others voiced concerns over the date from when an updated capital submission would be required — the so-called “as-of” date — and how much information would need to be included. “As far as the challenges that we face, the first thing is the as-of dates,” said Suzie Grady of Credit Suisse. “The as-of date is critical for host of reasons but one of the biggest lifts is the data cleanup. I think the industry is assuming that June 30 kind of smells right for the as-of date.”

The next challenge, said Grady, is how many scenarios the Fed will require. “We are sort of assuming there will be three scenarios but that’s not definite,” she added.

But perhaps her biggest worry was the amount of documentation the bank would have to provide. Depending on the scope of the data, the input from multiple stakeholders across the organization could be significant. “I would say my most dire question that needs to be answered are the doc requirements,” Grady said, adding that a bank’s capital plan can sometimes mean a thousand-page document itself and thousands of supporting documents.

“That’s a lot of effort to pull together,” she added. “It would be good to get a steer sooner rather than later because that has a big impact on how we run those cycles.”

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