Risk Review Comprehensive Capital Analysis & Review, CCAR: What does it mean for you?
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INTRODUCTION Welcome to the very first
importance of having a
edition of Risk Review this
comprehensive stress testing
year. As we edge closer
program is being constantly
to RiskMinds Americas,
validated by the world we
taking place in Chicago
live in.
this September 20-23, the last few months have been reminders of just how unpredictable and turbulent the global geopolitical and macroeconomic climate can be. With our lives being influenced by Brexit, an
It is the significant depth and breadth of content that marks RiskMinds Americas as a unique forum and it is our aim that this magazine will help to build on our quality, timely content made possible by our growing community.
impending new U.S. President and negative interest rates, to name just a few challenges, it is fundamental for risk managers to be aware of every possible risk eventuality and the potential implications
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these factors will have on our evolving financial landscape.
The topic of CCAR is therefore especially timely for us to be addressing in Risk Review this quarter. This is not only
Ed Stapley,
because of the necessity
Editor-in-Chief,
for banks to get to grips
RiskMinds
with the specifics of today’s regulatory frameworks, but fundamentally the
CONTENT INTRODUCTION
Page 2
THE ORIGINS OF CCAR
Page 4
STRESS TESTING
Page 6
DIFFERENCES WITH OTHER CCAR TESTS
Page 8
THE CHALLENGES
Page 10
THE ORIGINS OF CCAR BY LYNN STRONGINDODDS
The global financial crisis shook the
DFAST test because it relies on the
banking industry to its core and the
yearly supplied CCAR scenarios. If
ramifications are still reverberating
they are submitting both they must
today. However, the US banking
do it at the same time.
system is much more robust and resilient today than it was before
There are also variances to the stress
2008 thanks to a tighter regulatory
testing. While the DFAST assesses
framework imposed by regulators
whether a BHC has sufficient capital
across the globe.
to absorb losses and continue operating in severely adverse
In the US, key planks in the Federal
conditions, the CCAR evaluates the
Reserve’s programme are the
business’ policies and strategies
Comprehensive Capital Analysis and
for effectively handling various
Review (CCAR) and the Dodd Frank
scenarios.
Act stress testing (DFSAT). They both put banks through their paces
As for the logistics, the larger banks
in the shape of an annual stress
have to submit DFAST worksheet
testing exercise. The aim is to assess
with each year’s CCAR worksheets
whether the banks have sufficient
while their smaller counterparts –
capital to continue operations
those BHCs operating between $10
throughout times of economic
and $50 billion only have to submit
and financial stress.
a DFAST worksheet.
Difference between CCAR and DFAST: CCAR and DFAST are two complementary components of the federal government’s assessment of a bank holding company’s (BHC) stress resilience. One of the main differences between the regulations is the size of the institutions – the CCAR applies to bank holding companies with assets over $50 billion while the figure is $10 billion for DFAST. However, even the smaller BHCs must have at least partial knowledge of CCAR legislation to complete their
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5
STRESS TESTING
The driving force behind CCAR
handle a future economic shock.
recession or mild deflation that
is the collapse of Lehman Brothers
They test the bank’s ability to
causes weakened economic activity.
in 2008 and the systemic risk that
remain “well-capitalised,” with a
Last but not least is severely adverse
swept across the world’s banking
minimum Tier 1 common equity
–a theoretical situation involving
sector. The legislation substantially
ratio of 5%, even in a severely
a severe global recession with
strengthens the Fed’s approach
negative economic scenario.
U.S. unemployment rates rising
of ensuring that large BHCs have
to 10, a heightened period of
thorough and rigorous processes
The qualitative review is also an
corporate financial stress, and
for managing and allocating their
important component and has
negative yields for short-term U.S.
capital resources. Large, complex
accounted for the majority of
Treasury securities.
BHCs are expected to hold sufficient
the Fed’s capital plan objections
capital in order to maintain access
over the last three CCAR cycles. It
to funding, play a role as credit
focuses on risk management and
intermediaries, meet their obligations
governance of the capital planning
to creditors and counterparties, and
process of each CCAR firm. Key
to continue operations, even in an
items evaluated include data quality,
adverse environment.
risk identification, forecasting processes, capital policies, and
In the pre-CCAR era, firms looked
internal controls to ensure the firms
to simulation-based approaches
have a sound capital adequacy
to analyse millions of scenarios,
process. Management’s dividend
calculate risk-based capital
and share repurchase decisions is
requirements and manage portfolios.
also scrutinised to see whether there
Although the numbers crunched were
is enough capital retained to cover
sound, some of these approaches
risks in a stress environment.
were a bit abstract and often difficult to interpret for senior executives.
Not surprisingly, the scenarios vary from year to year so they aren’t
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Today, the new rules require stress
too predictable although they are
tests to be submitted according to
broken down into three categories.
several macroeconomic scenarios
Baseline is predicated on the average
provided by the Fed, and are used
projections of economic forecasters
as protection to check for whether
while adverse is a hypothetical
a bank’s system could theoretically
situation involving moderate
Institutions continue to have material unresolved supervisory issues that critically undermine its capital planning process
All participating BHCs are expected
regional player Huntington
shareholders unless expressly
to create two of their own scenarios
Bancshares of Ohio could keep
authorised. The Fed had previously
and supply actions plans. One must
trading with capital above the
noted banks that demonstrate a
be based on baseline expectations,
regulators’ minimum levels.
chronic inability or unwillingness to
where the other uses a stress
correct deficient behaviour can also
scenario, meaning that each BHC is
Only two banks failed this
be subject to enhanced regulatory
required to submit action plans for
year - Santander Holdings USA
actions, including but not limited to
five total scenarios. The exam also
and Deutsche Bank Trust Corp.
cease-and-desist orders. However,
requires every mandated bank to
The results marked the second
Santander and Deutsche Bank are
submit a “capital action plan” for the
consecutive failed test for Deutsche
seen to have made progress and are
following four quarters. The Fed then
Bank, and the third straight year
committing more resources to the
assesses that bank’s financial health
that Santander has flunked. While
stress-testing process.
and gives the bank a score. This is
both foreign-owned banks met the
not simply a “pass/fail” assessment
minimum regulatory capital ratios
The stress-testing struggles being
but banks are graded in terms of
that are required by the Fed, they fell
encountered by Santander and
exactly how strong they are.
short on qualitative grounds, just as
Deutsche Bank do not reflect the
they did in 2015.
experiences of all foreign-owned
The Latest Round
banks. For example, BBVA Compass,
The latest round of stress tests in
The regulator noted that the
BMO Financial, HSBC North America
June 2016 showed that the largest
institutions continue to have
and MUFG Americas were among
US banks would be able to withstand
“material unresolved supervisory
those that passed as did first-time
the worst case scenarios. Every one
issues that critically undermine
participants BankWest Corp. and TD
of the 33 institutions that took the
its capital planning process. These
Group US Holdings, both of which are
first part passed which meant that
included deficiencies in risk-
also owned by foreign banks.
they not only built up significant
management processes and stress-
Four additional foreign banks –
capital since the 2007-2009 financial
testing processes. The key question
Barclays, Royal Bank of Canada, UBS
crisis but that management teams
now is what the consequences will
and Royal Bank of Canada – are
have largely proven the merit of their
be for repeated failures. Santander is
expected to be included in CCAR
internal disaster planning to the Fed.
the first bank to fail CCAR for three
starting in 2018.
Even if total losses over a nine-
years in a row.
quarter period reached $385bn, the test revealed that the banks ranging
One punishment for failing the
from Wall Street power house
test is not being allowed to make
JPMorgan Chase to heavyweight
any capital distributions to their
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DIFFERENCES WITH OTHER CCAR TESTS
international operations to the
They note that “our assessment of
effects of a commercial real estate
the cost of likely CCAR changes,
bubble for those with large loan
incorporating a “cost of stress”,
portfolios in the sector. Additionally,
limited capital actions and GSIB
the Fed will focus on transparency
Method 2 (the estimates for the
of the end-to-end capital planning
capital surcharge) translates to an
process, from loss modelling for
incremental 75-150 basis points of
various portfolios to dividend pay-
required common equity tier (CET)
According to Moody’s Analytics
out decisions.
1 for Bank of America, Citigroup,
Ed Young, Senior Director on
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JPMorgan Chase and Wells Fargo.
the Stress Testing and Capital
A tougher stance
Our analysis now uses the 2016
Planning Team and Anna Krayn,
Eight banks that are deemed to
DFAST cost of stress as a starting
a Director, responsible for business
be global systemically important
point and relies on existing forecast
development for stress testing and
bank holding companies (GSIB)
RWA changes and capital actions.”
capital planning solutions, while a
will face a more onerous
majority of the items the Fed covered
examination in the next round
Their research also assumes that the
in the qualitative review were similar
in 2018. They will be required to
CCAR is then the binding constraint
to past CCARs, there were a few
incorporate capital surcharges
on capital and relative to current
differences.as the enterprise-wide
ranging from 1% to 3.5% of their
non-stressed required fully-phased
stress testing processes mature
total risk weighted assets into
in Basel 3 CET 1 minimums.
across the industry.
their minimum capital thresholds.
In the past, expectations revolved
They include JPMorgan Chase, Bank
around loss modelling, capital
of America, Wells Fargo, Citigroup,
policy, and model risk management
Goldman Sachs, Morgan Stanley,
processes. This year the focus has
Bank of New York Mellon and State
been on risk identification, process
Street. The aim is to increase capital
integration, and scenario design.
requirements to a level at which
“In other words,” they point out,
banks consider selling assets and
“the Fed will be trying to determine
relying less on wholesale funding.
if each bank has its arms around
The changes could hurt profitability
all of the different types of risks it
for banks’ profitability, according to
may face, from extreme currency
Credit Suisse analyst Susan Roth
fluctuations for firms with extensive
Katzke and her team.
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THE CHALLENGES As the tests indicate, banks are
that they have sufficient capital
However, despite the improvements
generally in a much healthier state
available to operate soundly even
in data quality, analysis and loss
than they were eight years ago and
under extreme economic duress,
modelling for all large banks, the
better equipped to weather most
and whether or not they have what
three analysts contend that there is a
unexpected storms. However, as Ed
the regulator calls “a robust, forward-
need for additional scenario analysis
Young is a senior director on the
looking capital-planning process”
beyond the Fed’s small set of
stress testing and capital planning
that accounts for their unique risks.
deterministic scenarios (i.e., baseline,
team at Moody’s Analytics, argues,
Meeting these requirements has not
adverse and severely adverse).
“One of the benefits of the exercises
been an easy task. This is because
“Market disruptions can be driven by
is there is greater supervision to
macro-economic variables are not
a host of real or imagined threats.
ensure that banks are stronger and
easily predictable and there can
If they were not nearly impossible
more resilient, but more work needs
be an infinite number of variables
to predict, they would not be “shocks,”
to be done.”
influencing scenarios and outcomes.
they note.
This has required banks to build On the positive side, Young along
effective models that produce
One of the problems is the
with Krayn, and David Little,
accurate data, identify key risks
deterministic analysis that banks are
Managing Director, Head of the US
and respond accurately.
forced to use. Although intuitively
Enterprise Risk Solutions and Stress
it is a well understood narrative
Testing Sales Teams point out that
and cohesive framework across
the Fed has established a process
the enterprise, the negative is the
that emphasises forward-looking
inability to explore the impact of a
financial metrics to improve capital decisions as well as a standardised benchmark for the severity of an enterprise-wide stress test. In addition, banks not only have to respond to the Fed’s home-grown scenarios but also develop stress scenarios tailored to its specific risk profile. In the past, the Fed would evaluate capital at a moment in time whereas under CCAR banks need to prove
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There needs to be a more holistic view and greater investment in operational efficiency.
broad range of possible scenarios, according to the analysts. They also argue that while “firms have spent a significant amount of time, effort and money chasing the goal of precisely predicting the impact of a few hypothetical scenarios, precision has been emphasised much more than the need to understand a much broader set of possible outcomes. Ironically, the latter, in many cases, is the more useful tool for a risk manager.”
To rectify the situation, Young
firms to consider many possible
replace outdated ALM systems with
believes that there needs to be
outcomes without the l burden of
current, CCAR/DFAST-compliant
stronger links between these
current stress testing processes.
ALM systems which can calculate
processes and dynamic risk
As the enterprise stress testing
credit losses under various economic
management tools, internal controls
framework matures, the financial
assumptions as it generates the
and governance. “In 2015 the Fed
system will become much more
balance sheet run off, additions,
emphasised in its guidance that
resilient to economic downturns and
and income statement flows. In
banks need to continue to develop
market shocks.”
order to build the most effective
sound processes for integrating the
model though, banks must have
risks of their specific business model
The other big challenge banks
the ability to migrate economic
into their stress testing process,” he
have faced is the ability to find and
assumptions into their credit ratings
says. “This means that banks will
pull together the right information
within the ALM system, according
need to increase the number and
to meet the Fed’s requirements,
to Newcomer.
frequency of scenarios they consider
according to Will Newcomer, Vice
when making capital decisions.
President of Product and Strategy,
Conclusion
U.S. Risk & Compliance, Wolters
The CCAR is an annual exercise
The analysts recommend a three
Kluwer. “In the past many of these
by the Federal Reserve to assess
pronged approach be adopted
processes have been manual. While
whether the largest bank holding
which includes better integration
the largest banks have the resources
companies operating in the U.S.
of risk identification processes, the
and IT teams to build the technology
have sufficient capital to continue
development of a strategic planning
themselves, most of the banks have
operations throughout times of
framework and the incorporation of
looked to software vendors to provide
economic and financial stress and
a wide range of possible outcomes
the solutions.”
that they have robust, forward-
into the scenario design process.
looking capital planning process.
While these will be time-intensive
Newcomer notes though that banks
The origins are in the global financial
and costly endeavours, the end result
leveraged their asset and liability
crisis and the objective is to avoid
will be a much more robust risk
management (ALM) systems whose
a Lehman Brothers style collapse.
management tool for banks.
origins are in the interest rate
However, there are still kinks in the
deregulation era of the 1980s. They
system and some analysts believe
“There needs to be a more holistic
were originally designed to identify
a more holistic approach needs to
view and greater investment in
interest rate risk resulting from the
be adopted.
operational efficiency,” say Young.
maturity mismatch between assets
“The industry is evolving and new
and the liabilities that fund them.
tools will be developed to enable
Fast forward to today and banks can
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