Bank Stress Testing
Our client, Eastern Capital Bank, is a mid-sized U.S. commercial bank with $75 billion in total assets. Recently, the Federal Reserve updated its CCAR (Comprehensive Capital Analysis and Review) requirements for banks over $50 billion in assets. CCAR is a regulatory framework that tests how banks would perform under severe economic stress — for example, during a financial crisis.
Eastern Capital Bank’s CFO has asked EY FSO to help identify any weaknesses in their current capital planning process that could put them at risk of failing future CCAR tests. Before reviewing specific processes or numbers, how would you structure the problem to identify potential gaps in their capital planning and stress testing process?
Case Exhibit
To identify gaps in Eastern Capital Bank’s capital planning and stress testing process, we can organize the problem into four broad, mutually exclusive categories:
I. Risk Modeling & Assumptions
- Alignment of key variables like unemployment, loan loss rates, equity market decline, and interest rate changes with regulatory scenarios.
- Model calibration methods and validation processes.
- Frequency and robustness of stress scenario development.
II. Capital Adequacy & Financial Resilience
- Current Tier 1 capital ratio versus peer averages and regulatory minimums.
- Dividend payout policies and their impact on capital buffers.
- Contingency plans for capital shortfalls under stress conditions.
III. Process & Governance
- Board-level and senior management involvement in capital planning decisions.
- Documentation, audit trails, and accountability for stress testing processes.
- Internal controls and escalation procedures when gaps are identified.
IV. Regulatory Alignment & Benchmarking
- Degree of alignment with CCAR (Comprehensive Capital Analysis and Review) regulatory frameworks.
- Benchmarking against peer banks' capital planning standards.
- Proactive engagement with regulators and pre-emptive gap assessments.
