A casual observer – or harried community banker – might shrug off “stress tests” as a concern of large banks only. But local rumblings indicate smaller banks might sooner or later have to shoulder these burdens, too.
At the moment, only institutions deemed “systemically important” would be required by regulators to run an annual federal stress test and create a living will to safely dismantle themselves in the event of failure.
But unofficially, stepped-up stress testing, both as an industry practice and possibly as a future regulatory mandate, appears to be trickling down to smaller institutions.
Regulators at a recent California Bankers Association meeting affirmed publicly that they are developing tests for smaller banks. Locally, some community bankers say that regulators might come to expect increased stress testing, according to John Carusone, president of Connecticut-based Bank Analysis Center, citing conversations with client banks.
“What I have heard is that there is a new wave of scrutiny emerging from regulatory authorities that involves complex levels of stress testing, applied to the community banking industry, which is similar to what the 20 largest banks went through in 2009,” he told Banker & Tradesman, although he cautioned that these were early reports slim on details. Still, it’s enough to spark concern among already-taxed bankers, he added.
Living Will
At a June 14 SunGard Ambit-sponsored banking conference in Boston, ex-regulatory advisor Thomas Day took the idea a step further. Whether required by regulators or not, stress tests are already considered sound industry practices. Soon, the expanded stress tests will also be joined by a form of living wills, he said.
Day, managing director of risk and policy at vendor SunGard Ambit, a global banking services company with offices in New York, was previously a policy advisor at the Office of the Comptroller of the Currency and the Federal Reserve. In an interview with Banker & Tradesman, he expounded upon the idea of expanded testing for smaller banks and why it’s a sensible course of action.
“It just makes sense for [smaller banks] to think about ‘If I got into trouble, how would I recover?’” Day said. While the term “living will” generally refers to a plan for safely dismantling a dying bank, Day expanded the idea to include emergency action plans that might save troubled banks, or pieces of troubled banks, as well.
That means contingency plans for selling off assets or separating troubled operations to save the major part of the operation. The size of the bank is irrelevant, he added, as recent experience has shown that plenty of longstanding community banks can quickly die. Better by far, he said, to stress test to find one’s weak points and form an emergency plan, just in case.
Bankers might think they’re out of the woods, but economic indicators are still not promising, Day said. Scrubbing through to analyze weaknesses via stress tests and making worst-case-scenario plans should still be very much on bankers’ minds.
“No one believes it can happen to them, until it happens to them,” he warned.
A Useful Exercise
While Day floated the idea of emergency planning, the current realities of stress testing got more attention from the SunGard conference’s bankers. One executive from Connecticut-based regional institution Webster Bank – which has locations in eastern Massachusetts – took the stage to share his stress-testing experiences.
Carl Carlson, director of planning and analysis for Webster, said the bank knew it would have to conduct tests because it had been a recipient of Troubled Asset Relief Program funds, which were repaid at the end of last year. Since the bank viewed regulator-mandated stress testing as inevitable, he added, it “dove right in,” and found the experience a useful exercise.
“It does help to go through this, to find where your risks are,” he said.
As far as the Massachusetts Division of Banks is concerned, community bankers shouldn’t panic – they won’t be required to fulfill the same level of stress-testing as giant institutions, Commissioner of Banks David Cotney told Banker & Tradesman. He did acknowledge that risk management scrutiny has increased, but said regulators were aware of the burdens on banks, and were willing to work with them to keep requirements reasonable.
Still, Carusone said, rumors about regulators making a more exacting stress test mandatory is a dispiriting thought to bankers already buckling under the weight of the Dodd-Frank Act. It appears stress testing will get its own set of strict regulatory guidelines, for any bank under a regulatory order.
If regulators do opt to start checking in on bankers’ stress tests, that means testing would have to have an audit trail – and that requires more resources.
“Some of the smaller segments of the banking industry are possibly going to have a difficult time devoting the resources to this level of exacting analysis,” he said.
