Featured Product

    Beverly Hirtle of New York FED on Supervisory Stress Testing Design

    October 11, 2018

    During a speech at the 2018 Stress Testing Research Conference in Boston, Beverly Hirtle of NY FED discussed the evolution of design of the supervisory stress testing. She briefly reviewed how stress testing emerged as a key supervisory policy tool and how the original goals of the Supervisory Capital Assessment Program (SCAP), Comprehensive Capital Analysis and Review (CCAR), and Dodd-Frank Act Stress Testing (DFAST) affected modeling and design choices. She then highlights the gaps left by the current approach, before finally suggesting the areas where new research could help push forward the frontier of stress test modeling, both of specific elements that go into the stress test calculation and of the broader impact of the stress testing programs implemented in the United States and elsewhere.

    She detailed the design choices made for stress testing and highlighted three important tactical issues in supervisory stress test modeling that research can help address:

    • Additional ways of projecting revenues and non-credit expenses in stressed environments is a particularly ripe area for additional work.
    • Concerns about measuring model risk. How to assess errors from models intended to capture performance under stressed conditions when those conditions have not yet been realized and might not be in the historical data?  How to assess the uncertainty or margin of error around loss and revenue projections derived from models that can be quite complex, often involving multiple estimation steps?  How to assess the error around the ultimate calculation of stressed capital ratios? Howto measure correlation in model errors in a tractable and practical way? How much model risk owes to the decision to develop complex models for many individual pieces of the net income and regulatory capital ratio calculations, instead of using simpler, "top down" estimation approaches?
    • Role of simpler, easier to estimate models of net income and its key components. Federal Reserve modeling teams have already developed a set of these "benchmark" models that produce loss and revenue estimates as a comparison to the projections from the more sophisticated and complex production models. Increasing deviations between benchmark and production projections could highlight emerging (or declining) areas of risk. A related area of research could address optimal ways for supervisors to assess the signal when benchmark and production model results deviate significantly from one another. Also, these simpler models could potentially form the basis of a more dynamic, system-focused stress test analysis that builds in the linkages and feedback not currently captured in CCAR and DFAST stress testing programs. 

    Next, she highlighted issues where additional research could help guide the evolution of the supervisory stress testing regime. A related set of questions concerns how stress testing affects the cyclicality of capital requirements and what degree of cyclicality is appropriate. How does cyclicality of stress testing interact with other cyclical elements, such as the countercyclical capital buffer and the incoming current expected credit loss (CECL) approach to loan-loss provisioning? Finally, one concern that has been raised about the FED approach to stress testing and integration into the CCAR program is that of "model monoculture," which is the idea that banks will be "incented" to develop models that mimic the FED models rather than developing their own independent approaches: "Significant commonality in modeling approaches in the banking system could result in banks adopting similar risk exposures and hedging techniques, exposing the sector to additional systemic risk and potential future instability. How do we measure this risk? What should we think about differences (and similarities) between bank-generated and supervisory stress test results, both for a particular stress test cycle and over time? What disclosure and transparency policies about supervisory models can address these concerns, while still supporting insight and credibility into the DFAST and CCAR stress testing programs?"

    She concluded by saying that these are the questions that challenge policymakers as the regulatory and supervisory regime that was put in place following the crisis is re-examined and evolves in the wake of that re-examination. "A disciplined analytical approach to these topics is critical in weighing future design choices, such as those made during the initial implementation of SCAP, CCAR and DFAST stress testing. Research on these topics could make substantial and meaningful contributions."

     

    Related Link: Speech

    Keywords: Americas, US, Banking, Stress Testing, DFAST, SCAP, CCAR, NY FED, BIS

    Featured Experts
    Related Articles
    News

    APRA Updates Lists of Validation and Derivation Rules in December 2019

    APRA updated the lists of the Direct to APRA (D2A) validation and derivation rules for authorized deposit-taking institutions, insurers, and superannuation entities.

    December 13, 2019 WebPage Regulatory News
    News

    APRA Finalizes Prudential Standard for Credit Risk Management of Banks

    APRA updated the prudential standard on credit risk management requirements (APS 220) for authorized deposit-taking institutions, post a public consultation.

    December 12, 2019 WebPage Regulatory News
    News

    EIOPA Consults on Guidelines on ICT Security and Governance

    EIOPA issued a consultation on guidelines on the Information and Communication Technology (ICT) security and governance by insurers.

    December 12, 2019 WebPage Regulatory News
    News

    BCBS Consults on Design of Prudential Treatment for Crypto-Assets

    BCBS published a discussion paper on the design of prudential treatment for crypto-asset exposures of banks.

    December 12, 2019 WebPage Regulatory News
    News

    NCUA Approves Delay of Risk-Based Capital Rules Until January 2022

    The NCUA Board held its eleventh open meeting of 2019 and approved a final rule to delay the effective date of the risk-based capital rules for credit unions to January 01, 2022.

    December 12, 2019 WebPage Regulatory News
    News

    APRA Issues Operational Risk Rules, Consults on Reporting Requirements

    APRA published an updated prudential standard APS 115 that sets out operational risk requirements for authorized deposit-taking institutions in Australia.

    December 11, 2019 WebPage Regulatory News
    News

    ESMA Updates Q&A on European Benchmarks Regulation in December 2019

    ESMA updated the question and answers (Q&A) document on the European Benchmarks Regulation.

    December 11, 2019 WebPage Regulatory News
    News

    APRA Decides to Keep Countercyclical Capital Buffer for Banks at 0%

    APRA announced its decision to keep the countercyclical capital buffer (CCyB) for authorized deposit-taking institutions on hold at zero percent.

    December 11, 2019 WebPage Regulatory News
    News

    ESMA on Draft Amendments to Indices and Recognized Exchanges Under CRR

    ESMA issued the final report on draft amendments to the Implementing Regulation (EU) 2016/1646, which specifies the main indices and recognized exchanges, under the Capital Requirements Regulation (CRR), that are relevant to credit institutions and investment firms subject to prudential requirements and trading venues.

    December 11, 2019 WebPage Regulatory News
    News

    FED Extends Consultation Period for Capital Requirements for Insurers

    FED is extending comment period for the proposed rule establishing risk-based capital requirements for depository institution holding companies that are significantly engaged in insurance activities.

    December 10, 2019 WebPage Regulatory News
    RESULTS 1 - 10 OF 4316