Apr 17 2014, 2:50pm CDT | by Forbes
The Dodd-Frank Act (DFA) established the stress tests and Comprehensive Capital Analysis and Review (CCAR) to determine the stability of the banking system. Since the stress and capital requirements tests were first implemented in 2009, we’ve observed that it has tended to help banks gain a better understanding of their overall risk profiles, better manage risks across lines of business and foster confidence, both among regulators and in the marketplace.
There is little doubt, nearly five years later, that most banks have improved their capital position and their stability along with their profitability. The key question now is how banks position themselves and execute their business strategy under the new capital structures to drive competitive advantage, improve profitability through innovation and deliver value to the shareholder.
The Federal Reserve, which administers the CCAR process and stress tests, has provided guidelines for banks regarding the uses of excess capital. The Fed has noted, for example, that dividend payouts are to be conservative and that planned dividend payout ratios above 30 percent of projected after-tax net income “will receive particularly close scrutiny,” as was reported by Forbes.com and others.
For banks of all sizes, perhaps the greatest challenge resulting from CCAR and stress testing is the time and effort it requires for already overburdened leadership across risk and finance – as well as the IT support functions. As the processes mature and the banks view CCAR as a strategic tool for decisions beyond compliance, they have continued to make investments, developing more robust operating frameworks, applying quantitative forecasting methodologies, updating infrastructure and technology with analytics and data aggregating tools, and fine-tuning execution capabilities. Many banks are looking for better systems – and better data – to improve their stress testing and capital planning process. Large banks, in particular, are implementing automation frameworks to support risk modeling and take some of the burden off of their risk and finance officers.
While many banks have invested in point solutions and software, opportunity remains for banks to establish robust frameworks that integrate data, modeling, analytics and reporting capabilities across all lines of business and all geographies.
Looking ahead, there are five elements that will help large and mid-size banks better prepare for the 2015 edition of stress testing and CCAR submission:
Regulatory authorities have found stress testing to be a useful tool to assess the strength of the U.S. financial system. The banks can take advantage of CCAR and use the process as a strategic tool to develop strategy and manage their business along with their existing internal processes. A systematic, integrated approach to stress testing allows banks to see where they are vulnerable and where pressure points might emerge in a given distress environment. Stress testing provides a key diagnostic that can help banks determine whether their capital plans make sense or whether additional steps should be taken to strengthen reserves and increase profitability.
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