FED published a technical paper that describes the Forward-Looking Analysis of Risk Events (FLARE) model. FLARE is a top-down model that helps assess how well the banking system is positioned to weather exogenous macroeconomic shocks. FLARE estimates banking system capital under varying macroeconomic scenarios, time horizons, and other systemic shocks. The paper describes the major model assumptions and the projection procedures and addresses how the underlying structures of DFAST and FLARE differ and how their results compare. The paper also outlines the current plans to enhance FLARE.
While Dodd Frank Act Stress Tests (DFAST) and the Comprehensive Capital Analysis and Review (CCAR) exercises are critical policy tools for assessing the health of large banks, FED has worked to build additional tools to assess the resilience of the banking system and to address macro-prudential goals. The Forward-Looking Analysis of Risk Events (FLARE) model is one such tool. FLARE complements DFAST in at least three ways:
- First, using publicly available DFAST macro scenarios, FLARE forms a benchmark assessment of banking system resiliency, as measured by changes in banking system capital.
- Second, FLARE is flexible. Its specifications are easily updated to reflect the evolving banking system financial conditions, the length of scenarios can be changed, and alternative data sources can be incorporated. FLARE’s modularity also allows satellite models to build in feedback effects and fire sales.
- Finally, because FLARE primarily uses public data, it can test the financial strength of bank holding companies, including those not in DFAST.
FLARE can be adapted to address macro-prudential stress testing goals. While the DFAST exercise remains critical to assessing banking system vulnerabilities and individual large bank safety and soundness, many macro-prudential policy topics, such as funding shocks and fire sales, are outside of the current structure of the public DFAST process. FLARE can be used to answer questions that may not be addressed by public DFAST scenarios. As an example, FLARE was recently used to assess the impact of prolonged low interest rates, reduced term spreads, and modest gross domestic product (GDP) growth on banking system performance. The tool also informs judgments of the resiliency of the entire banking system, not just large banks, and can be used to assess the relative severity of different macroeconomic scenarios. FLARE uses FR Y-9C data to project bank holding companies' earnings, losses, and capital under varying macroeconomic scenarios.
With respect to the future plans for FLARE, the model development will likely focus on two types of improvements in the short-term. First, several loan portfolios estimated in FLARE could be improved by including risk-taking data available through FR Y-14 and other sources. Similar to the refinements implemented for credit card net charge-offs, the first priority is to focus on incorporating risk measures that add to the macro sensitivity of the model and inform loss estimates. Second, to bring more depth to FLARE as a macro-prudential tool, the balance sheet needs to be more dynamic. As part of that, the current funding shock overlay can be improved and longer scenarios can be considered to incorporate a prolonged period of very low interest rates or a “double-dip” recession. In addition, the future versions of FLARE should estimate how fire sales may pose a risk to banking system resiliency.
Related Link: FED Paper
Keywords: Americas, US, Banking, Stress Testing, FLARE Model, Top Down Stress Test, DFAST, CCAR, Systemic Risk, Regulatory Capital, Fire Sales, FED
Previous ArticleFDIC Publishes Annual Report for 2019
The European Commission (EC) published a report summarizing responses to the targeted consultation on the supervisory convergence and the single rulebook in the European Union (EU).
The Office of the Superintendent of Financial Institutions (OSFI) published an update on the discussion paper that intended to engage federally regulated financial institutions and other interested stakeholders in a dialog with OSFI, to proactively enhance and align assurance expectations over key regulatory returns.
The European Central Bank (ECB) published its opinion on a proposal for a regulation on European green bonds, following a request from the European Parliament.
The Advisory Scientific Committee (ASC) of the European Systemic Risk Board (ESRB) published a report that explores the expected impact of digitalization on provision of financial and banking services, and proposes policy measures to address the risks stemming from digitalization.
The European Banking Authority (EBA) announced that the guidelines on the reporting and disclosure of exposures subject to measures COVID-relief measures shall continue to apply until further notice.
The Swedish Financial Supervisory Authority (FI) announced that the capital adequacy reporting as at December 31, 2021 must be done by February 11, 2022.
The Central Bank of the Philippines (BSP) issued communications covering developments related to online lending platforms, open finance framework and roadmap, and on the expected regulations in the area sustainable finance.
The Board of Governors of the Federal Reserve System (FED) published the final rule that amends Regulation I to reduce the quarterly reporting burden for member banks by automating the application process for adjusting their subscriptions to the Federal Reserve Bank capital stock, except in the context of mergers.
The European Banking Authority (EBA) published its assessment of risks through the quarterly Risk Dashboard and the results of the Autumn edition of the Risk Assessment Questionnaire (RAQ).
The Malta Financial Services Authority (MFSA) updated the guidelines on supervisory reporting requirements under the reporting framework 3.0.