What is Capital Planning & Stress Testing?
Stress testing quantitatively evaluates potential adverse macroeconomic environments. Through accurate stress testing and capital planning, your institution can ensure the integrity in the capital planning process, evaluate credit risk, and confirm risk assessments are based on assumptions related to potential adverse external events. It is essential that you are prepared.
Capital Planning & Stress Testing is a Must
Stress testing offers key insights about your institution’s financial positions that exceed regulatory requirements, making stress tests a must for all depositories. ALM First’s comprehensive examination of the balance sheet allows you as a leader to critically evaluate your current position and potential for success within various scenarios.
Accurate, detailed stress testing analyses provide:
- Confidence that your institution has adequate capital to survive a market downturn
- Assurance of adequacy of allowance for loan and lease losses
- Identification of possible future problems, such as an over-concentration
- Improved decision-making as management sees the need to set risk-tolerance levels
- Enhanced capital and asset planning by verifying risk-reward assumptions
- Clarification of the institution’s position to the regulators
- A diagnosis of areas needing strategic and operational improvement
The Value of ALM First
Establishing and executing a capital stress testing process requires time and modeling capacity. You can benefit by partnering with ALM First – we are experienced in developing an organized approach that helps keep the program moving smoothly.
ALM First will:
- Run required scenarios: Scenario simulations are critical. As part of stress testing, the Federal Reserve issues scenarios that incorporate a baseline status, as well as those that assume adverse and severely adverse economic environments.
- Implement assumptions about loss and recovery: A cornerstone of capital stress testing is determining the assumption of principal losses and severities. To ensure assumptions are appropriately designed for the balance sheet, delinquency, and charge-off information should be captured across all collateral types. By understanding the depository’s performance in a typical environment, it will be easier to predict results under adverse market conditions.
- Execute analyses: Conducting regression analyses both on performance and on changes in macroeconomic variables will help an institution understand its sensitivity to economic factors. To be most helpful, these analyses should incorporate unique scenarios unrelated to current market performance, as they wouldn’t be included in the model projections.
- Prepare reports: To aid in strategic planning and auditing, testing, and capital planning, ALM First’s methods are transparent and well-documented for easy auditing. These include highlighting key variables, assumptions, and the institution’s sensitivity to particular changes. For maximum effectiveness, these credit-monitoring reports should be available during planning sessions, liquidity discussions, and profitability analyses.