Stress Testing: From Regulatory Burden to Catalyst for Business Transformation
Six years after the onset of the 2008 financial downturn, financial institutions are reconciled with the fact that more rigorous and frequent stress testing is here to stay. While banks must garner their resources to ensure compliance with increasingly demanding stress-testing standards, they should also find ways to put this investment to work to enhance the overall performance and profitability of their organizations.
In many cases, financial institutions remain focused on simply fulfilling the regulatory requirements of stress testing, and overlook an important opportunity to use the information gathered through these labor-intensive efforts to peer into their operational DNA and drive their institutions forward. Finding new ways to use this information as a proactive and dynamic management tool will help leadership gain new perspectives, improve decision making, and provide financial institutions with long-term value.
No longer just a check-the-box exercise to fulfill regulatory obligations, stress tests represent a complete dissection of a financial institution’s multiple risk types -- including credit, market, operational, and liquidity risk, as well as the impact of such risks on an institution’s balance sheet and income statement. Regulators are not the only ones who can benefit from this valuable data. Rather than looking at the narrow impact of stress testing, the Comprehensive Capital Analysis and Review (CCAR), the Dodd-Frank Act Stress Test (DFAST), and Basel III requirements, the information retrieved provides an enormous opportunity for senior leadership and boards of directors if the information unearthed through these deep dives into bank data is used to drive and refine management strategies moving forward.
For example, stress-test data can reveal undetected hypersensitivities of a loan portfolio to macro-economic factors. A bank can also use stress-test-related tools, such as data marts and ad hoc reports, to identify how well its risk profile aligns with management’s intended profile and analyst projections. With data scattered across so many different applications, an enterprise-wide analysis of risk is a rare opportunity to assess all risk positions objectively.
Realizing this important change will first require a significant cultural shift. Fundamentally, it means ensuring that information gleaned from stress tests continues to flow unimpeded from the bottom all the way up the chain to the board of directors level, and that leadership mandates the use of data at all levels to drive strategic and operational decisions. Stress-test outcomes, however, have been put to limited use at the highest levels of financial institutions, as the reports and data, historically, were treated as an “information only” item at board meetings.
While leadership has and must be inherently involved with the results and regulatory impact of stress-test results, it has historically been difficult to operationalize that information to safeguard the bank’s business model, and as such the responsibility to interpret and report the data has been left to others. These barriers must come down to optimize use of this valuable data. Simply put, banks must be able to present information and analysis gleaned from stress tests in a way that is understandable and actionable.
However, the volume and technical nature of the data makes this difficult. Thus it is critical that banks get a transparent view of stress tests across the enterprise. Advancing stress-test data to the boardroom requires more than changes in culture and process. There is an IT component to solving this problem and ensuring that data is delivered quickly and in a standardized format.
For many, extracting the most utility out of stress-test data will require creating a fully automated and integrated environment that improves data extraction and aggregation enterprise-wide and ensures the consistency of balance sheet data, risk data, market data, and qualitative data. Forward-thinking financial institutions understand that this transformation to an enterprise-wide platform is as much about increasing visibility and improving decision-making for senior leaders and directors as it is about fulfilling stress testing, CCAR, DFAST, and Basel III compliance obligations.
Having the ability to produce critical data on demand in nanoseconds holds great value for directors and senior leaders. While this level of speed is not required for a bank’s stress-testing program, this “real-time” view offers greater insight into the immediate and longer-term impact of any particular stress scenario and allows for a faster defensive response during periods of heightened market volatility.
Advancing stress-test data from the conference room to the boardroom gives leadership the best information available to make critical business decisions. This change will drive long-term value. Financial institutions must understand the role that stress test outcomes have in improving internal decision-making, long-term planning, and risk assessment. If firms can transform the ability to compile stress-test data into a useful framework that allows leadership members to strengthen their analytical capabilities, their organizations and shareholders will see dramatic benefits.
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Sonny Singh is Senior Vice President and General Manager of the Financial Services Global Business Unit at Oracle. His organization's responsibilities include sales, consulting, engineering, and support of Oracle products that focus on banking, insurance, and capital ... View Full Bio
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