Stressful time for banks

July 23rd, 2014 by Stephen Jones Leave a reply »

The European Banking Authority (EBA) last week launched a consultation on draft Guidelines setting forth criteria to identify institutions that are systemically important either at Member State or Union level, the so called ‘other systemically important institutions’ (O-SIIs). The ECB is reviewing the asset valuations of the euro zone’s 128 most important lenders and assessing their ability to withstand future crises. The results will be published in the second half of October, before the ECB takes on bank supervision on Nov. 4.

The ECB has been very transparent in engaging with banks and aims to provide as many details as possible to markets and other participants on progress in the comprehensive assessment and what the end of the process will look like,” said Danièle Nouy, chair of the ECB’s supervisory board. There is a sense of pragmatism that the ECB will try to achieve to minimize regulatory burden while ensuring methodological rigour with a schedule to start supervising around 120 banks in November.

The Guidelines aim at achieving an appropriate degree of convergence in the identification process as well as at ensuring a comparable, clear and transparent assessment of O-SIIs. The consultation runs until 18 October 2014.

The Economist: “This week the European Banking Authority, which co-ordinates national regulators, took a big step towards forcing banks to clean up their balance-sheets. It revealed details of the test it will administer to assess whether Europe’s banks can survive an economic shock or a downturn in markets. The previous set of “stress tests”, conducted in 2011, proved an embarrassing whitewash: some banks that had passed with flying colours came crashing down just a few months later. That left investors uncertain about banks’ true health, which in turn made it hard for banks to sell shares or issue bonds”

In April this year the EU presented stress tests as its final stab at fixing its fragile financial sector. Previous attempts gave pass marks to banks that soon needed new capital. The stress tests will allow “supervisors to address remaining vulnerabilities in the EU banking sector,” EBA Chairman Andrea Enria had said in a news release.

In October 23, 2013, the European Central Bank (ECB) announced the start of its
comprehensive assessment in advance of the supervisory role it would assume in November 2014. The goal of this mammoth undertaking is to restore confidence in the European banking sector that was lost during the financial and euro crisis and which could not be restored by the initial European stress tests in 2010 and 2011.The key building block of the exercise is the asset quality review (AQR).

The AQR is to assess whether:
- the assets held by the banks in Europe are properly valued,
- their exposures are correctly calculated,
- the collateral values are up to date,
- and even whether these assets should be reallocated to a different risk bucket.

The AQR comprises ten so-called work blocks that are scheduled to be executed on-site
between February 17 and August 1, 2014. 2 The AQR work is focused on concentrated the on-site credit file review (work block four) and the collateral and real estate
valuation (work block five) as well as the collective provision analysis (work block seven) and the valuation of level-three exposures (work block eight).

Blomberg reports that the European Central Bank will limit the amount of data it carries over from its asset review into a subsequent stress test and try to manage the burden from an unprecedented health check of euro-area lenders. Instead of entering all loan values, obtained in the Asset Quality Review that ends this month, into its stress test, officials will apply a “materiality threshold” to ensure only significant results are incorporated,

However Regulators have yet to sign off on the methodology, including a definition for that term.

Robustness Gauge

The stress test compare a bank’s balance sheets against a range of negative, hypothetical economic events to gauge their robustness. These tests are designed to help the ECB take over supervision with a clear picture of the banking system’s health.

Avoidance of Leaks

To give time for the market to digest the information before the ECB takes over supervision on Nov. 4, officials have penciled in a date of Friday, Oct. 17, to publicly.
disclose the outcome of the Comprehensive Assessment

The ECB aims to minimize the risk of results leaking early and causing market turmoil, warning banks from disclosing any findings resulting from the interaction between auditors and lenders, according to the document. To avoid a “disorderly publication of the outcome of the comprehensive assessment,” results will be given “very close to the public disclosure in order not to create disclosure obligations under the securities market regulation,” the document shows.

Banks will be informed of the AQR results in August only in cases where they have “a very severe capital impact,” to take corrective measures. When the final results will be disclosed banks will have two weeks to submit capital plans including corrective measures. The document showed that lenders will receive a detailed timetable for releasing results as well as dates for discussion of preliminary findings before publication.

Stress tests have become an important method of assessing whether financial institutions have enough capital to operate in bad economic conditions. In the USA under the provisions of the Dodd-Frank Act, both the Federal Reserve and large U.S. bank holding companies (BHCs) are required to do annual stress tests and to disclose these results to the public

In a letter issued 17 July 2014 The Office of the Comptroller of the Currency (OCC) proposes to adjust the timing of the annual stress testing cycle and to clarify the method used to calculate regulatory capital in the stress tests. The proposal also would provide that covered institutions will not have to calculate their regulatory capital requirements using the advanced approaches method in 12 CFR 3, subpart E, until the stress testing cycle beginning on January 1, 2016. The notice of proposed rulemaking was issued in the Federal Register on July 1, 2013, with a 60-day comment period.


The proposal would
• shift the dates of the annual stress testing cycle by approximately three months. The stress testing cycle that, under the current rule, begins on October 1, 2015, would instead begin on January 1, 2016.
• provide that no covered institution is required to use the advanced approaches capital methodology in its stress testing projections until the stress testing cycle beginning on January 1, 2016.

The annual stress test under section 165(i) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) only applies to national banks and federal savings associations with more than $10 billion in assets.

Middle East banks are not immune to such developments as they expand internationally and there is an increasing move to adopt BASEL iii compliance.

What should be done to address such requirements?
Some obvious steps include:
• Create a stress testing programme to define, coordinate and oversee bank-wide stress testing activities. Support this with comprehensive documentation that meets regulatory stress testing requirements and the board of directors governance obligations.
• Put in place systems robust automated systems for the aggregation, consolidation and management of relevant data bank-wide. A secondary step is to standardise and validate such data as much as possible, and to define policies and processed for data management, data clean up and data retention.
• Invest in a distress testing infrastructure that is an integral part of your compliance reporting . Such a solution should remove scope for manual error, and reduce administrative overhead by definition of business rules, and approval workflow processes that allow you to automates and streamlines the processed, manages data, orchestrates workflows, run what-if analysis, generate the regulatory and management reports provide notifications and alerts, and detailed audit trails and allow ad hoc inquiry on both current and historical data, against both current and historical reporting formats.

Its now time to reduce reliance on a patchwork of inefficient tools. Excel spreadsheets have their place for reporting outputs and analysis but random spreadsheets and manual cut and paste population of such sheets is not a substitute for a robust data warehouse.
• Such policies and systems must be able to work across divisions and business units, and geographies to meet the governance and compliance requirements of international standards and languages.
• Your technical solution must be able to scale up, and to easily accommodate different reporting frequencies, new tests and reports. This is where a data warehouse and integrated business processes for workflows, audits, security, aggregation etc. will pay dividends. the reports will change so the emphasis should be on selecting a robust, user friendly platform built-on proven, and familiar technology. For most banks that means the Microsoft stack of: SQL, SSAS, SSRS, with front end tools like Power BI, SSRS, Power BI, and SharePoint.

Ask us about BRSAnalytics.


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