By Rob Lee, Senior Vice President, AxiomSL
A byproduct of the 2008 financial crisis, Comprehensive Capital Analysis and Review regulations grew out of the federal government’s need to safeguard the nation’s banking system from another financial collapse. AxiomSL SVP Rob Lee explains the fundamental requirements of CCAR, noting that institutional stress tests and data collections are here to stay.
In the aftermath of the financial crisis of 2008-09, new federal regulations were established in an attempt to safeguard our banking system from another financial collapse. It was clear then, as it is today, that when looking at the new rules, banking laws and regulations have become a major concern for financial regulators. This new regulatory focus is, perhaps, no more apparent than the creation of the Supervisory Capital Assessment Program in 2009, and the subsequent annual Comprehensive Capital Analysis and Review (CCAR). The crux of these new stress tests is to improve capital adequacy and, ultimately, ensure organizational solvency under severe adverse conditions.
Only the nation’s largest 19 banks were subject to these stress tests, but soon enough the Fed required any bank with $50 billion and over in total assets to conduct them as well. In 2013, the Fed further expanded the reporting burden to U.S. banks between $10 billion to $50 billion in total assets. In addition to expanding the regulatory framework towards smaller-sized institutions, the Fed now requires foreign banks with U.S. operations exceeding $50 billion in assets to establish an Intermediate Bank Holding Company to conduct and report on CCAR.
As financial institutions prepare their capital plans for the 2015 CCAR process, the need to provide a more efficient reporting process is ever greater. This will prove to be a monumental challenge for banks without an automated process for completing CCAR regulatory requirements. Currently, Bank Holding Companies (BHCs) must provide a comprehensive plan that includes a detailed internal model inventory used for its capital projections. In addition, a BHC is expected to provide documentation outlining the risk identification process it uses to comply with the stress tests and their derivations.
Complying with CCAR provisions is a daunting task for all levels of banking organizations. Inadequate planning and problematic data only add to the challenge of the banks’ ability to supply regulators with a proper capital plan. Improving transparency and capital management within the financial institutions is paramount for financial regulators. One only needs to look at recent events to discover an example of poor capital planning. In 2013, several large banks were cited for weakness in their capital plans and were asked to resubmit after an initial review.
In 2014, Citigroup was under the malapropos spotlight after its capital plan was initially rejected.
“While Citigroup has made considerable progress in improving its general risk-management and control practices over the past several years, its 2014 capital plan reflected a number of deficiencies in its capital planning practices, including in some areas that had been previously identified by supervisors as requiring attention, but for which there was not sufficient improvement,” the Fed said in its report explaining the 2014 stress test results.
Assessing Banks’ Risk Positions
An efficient process to conduct the stress tests enhances the banks’ ability to view their comprehensive risk profiles. The often siloed nature of bank operations — with its attendant disparate data — makes it difficult to get a true enterprise-wide view of their risk profiles. CCAR regulatory initiatives were designed to further help banks bring large amounts of data together to gain a holistic view of their business operations. Senior management should use these initiatives as an opportunity to objectively assess all of the bank’s risk positions.
The Fed notes in its CCAR summary instructions and guidance document:
“In particular, the Federal Reserve seeks to ensure that large BHCs have thorough and robust processes for managing their capital resources, and that the processes are supported by effective firm-wide risk identification, risk measurement, and risk management practices. The Federal Reserve expects that a BHC’s capital planning adequately accounts for the potential for stressful outcomes and is supported by strong internal control practices and close and effective oversight by the board of directors and senior management.”
Banks can use the gleaned data from the stress tests to find previously undetected anomalies in loan portfolios or macroeconomic factors. Indeed, banks that are undergoing these stress tests can now see that they lead to better management and business decision making.
One such example is that dividend payments and stock buybacks require approval from the Fed, and stress test-compliant banks can boost dividends and return more cash to their shareholders. When the stress tests began in 2009, the Fed advised bank holding companies that under “safety and soundness considerations,” dividends should be substantially reduced or eliminated. Since then, the Federal Reserve reiterated that increased capital distributions would be considered unwise unless banks show they have a well-developed capital plan and sufficient amount of capital to continue operations during adverse market conditions.
Having invested more in technology and infrastructure, financial institutions are now better equipped to monitor enterprise risk and are more operationally efficient. In fact, the Fed was able to identify prominent issues within banks’ IT systems incapable of processing complex data, and communicate this to the regulated institutions. A 2013 Fed report on the financial industry’s progress noted that several banks’ pre-provision net revenue (PPNR) estimates were inaccurate due to data limitations and the use of suboptimal predictive models. Further, the Fed stated that some banks struggled because of weak management information systems. It determined that the banks best able to ensure quality results have information management systems that allow them to collect, standardize and validate large volumes of granular level data.
Improving System Integration, Data Quality
When investing in technology infrastructure for Fed stress testing, it is imperative that financial institutions of all sizes look to improve system integration and data quality, and find ways to improve efficiency. CCAR reporting is not a process that can continue to be conducted manually by relying on applications such as Excel, and it requires financial institutions to look into more comprehensive automated solutions. The financial technology vendor community provides tools and solutions that can be leveraged to address challenges with data integration, quality control, reporting and workflow management. The ideal solution is one that allows banks to easily drill down to source data to show regulators exactly how they arrived at their projections, as well as the logic or rules used.
Through smart investment, banks can leverage technology implemented to meet new compliance standards by also improving business processes. For example, investments made in risk management for the purpose of stress test requirements can also be used to analyze capital deployment decisions or spot potential M&A opportunities.
A good working relationship with regulators is critical to managing regulatory compliance, and transparency is the key to that relationship. Regulators want to fully understand how the banks arrive at their risk assessments, and to do this more efficiently, a certain level of transparency is vital. Institutions that can access their data quickly and drill down to the granular level achieve a high level of transparency necessary for CCAR provisions. Institutions that employ superior technology and governance processes will not only be able to comply with regulatory burdens, but gain from business process improvements and operational efficiency.
Banks will need more than just the right infrastructure and processes to meet CCAR requirements; they will need to establish an efficient way to manage and govern initiatives surrounding the new regulations as well. This means involvement from the board level on down. Organizational compliance can no longer be shunted to one corner of the business and ignored. It’s clear that Fed stress tests and regulatory data collections are not only here to stay, but will likely continue to expand further in scope.
Rob Lee is senior vice president of AxiomSL.
Credit: ABF Journal Magazine