This is a festive and welcome time of the year for almost everyone – everyone who is not a senior executive working in the US banking industry. Executives at the largest bank holding companies (“BHCs”) are otherwise occupied right now, completing an especially arduous compliance exercise called the Comprehensive Capital Analysis and Review (“CCAR”).
High Stakes as Bank Holding Companies Prepare for Annual Stress Testing
The Federal Reserve instituted CCAR in 2011 in order to strengthen its surveillance capabilities in the wake of the financial industry’s near-meltdown. CCAR is intended to judge the large BHC’s present capital adequacy and capital planning. While CCAR only applies to the holding companies with $50 billion or more of total consolidated assets, it sets the internal stress testing standards for other banks to follow. Where the Fed finds fault it will order capital improvements and/or interfere with the BHC’s dividend and other plans.
In a related and simultaneous operation, the Fed conducts Dodd-Frank Stress Testing (“DFAST”) on these same BHCs, while the Office of the Comptroller of the Currency (“the OCC”) requires similar testing from federally-chartered depositories with assets between $10 billion and $50 billion. DFAST is intended to judge the BHC’s prospective financial well-being in the face of sharp -- but hypothetical -- future deterioration in the economy. In addition to submitting to DFAST, the largest BHCs are required to conduct their own stress testing under both supervisory and BHC-drafted scenarios over the course of the year. Where the Fed observes sufficient post-stress deficiency, it will require the BHC to respond.
When Failure is Not an Option
The Fed updates its CCAR instructions every October. Instructions can and will change appreciably each year, often to the consternation of respondents. The Fed receives submissions from BHCs during the first week of January. Results of both DFAST and CCAR exercises are made public in March; CCAR with a delay of several days to allow BHCs to respond quickly to unwelcome DFAST results. BHCs pass, pass contingently, or fail CCAR. To fail is to invite the wrath of shareholders, clients and the financial press. To fail twice (which has not happened as yet to any respondent) is to invite the wholesale turnover of a BHC’s senior management.
Key Considerations for Meeting Capital and Dodd-Frank Requirements
Clearly, the stakes cannot be higher for major BHCs in meeting CCAR/DFAST challenge. There were 31 BHCs involved in 2015. As the major BHC prepares for this exercise, the following are some key considerations for CCAR/DFAST compliance:
- Suitability of the BHC’s planning and testing to its unique commercial profile
- Accuracy and timeliness of its data collection and interpretation
- Increasing automation throughout its operational systems
- Demonstration of strong and effective internal controls and governance
- Uniformity of credit and other risk metrics across its various operating entities
- Well-informed metrics of Estimated Probability of Default (EPD), and Loss Given Default (LGD) on C&I borrowers, trading counterparties, and other corporate exposures
- Continued readiness to respond to new and developing supervisory guidance on every front
RapidRatings works with several CCAR respondents. Our financial health rating and EPD calculations inform their CCAR submissions and help to make this part of the process less cumbersome. We will be standing by, alertly, when the Fed releases DFAST/CCAR results in March, as those results will no doubt have significant impact on the banking industry over the remainder of 2016.