On October 18, 2012, the OCC released stress testing guidance  for national banks and federal savings associations with $10 billion or less in total assets.  While the regulatory authorities clarified in May of this year that the Supervisory Guidance on Stress Testing for Banking Organizations with More than $10 Billion in Total Consolidated Assets would not apply to community banks, the OCC has now confirmed that the stress testing requirements in Dodd-Frank have “trickled down” to community banks, at least to those regulated by the OCC. The guidance states that appropriate stress testing should be performed at least annually.

Fortunately for community bankers, the stress testing guidance is greatly scaled back from the rules applicable to larger institutions, and the requirements are flexible in many respects. The guidance specifically states that the OCC does not specifically endorse any particular stress testing model and that banks with smaller scale and lesser complexity may be able to satisfy the requirements of the guidance by performing single spreadsheet analysis in some cases. This acknowledgement is in stark contrast to the onerous requirements applicable to larger banks, which can be read to require testing of all likely and unlikely scenarios using a wide variety of scenarios through the use of a number of different models.

Even though the guidance allows for a great deal of flexibility in implementing a stress testing model, each national bank and federal savings association should incorporate certain aspects of the guidance into its stress testing framework. The guidance states that every stress testing framework should include the following elements:

  • asking plausible “what if” questions about key vulnerabilities;
  • making reasonable determinations of how much impact the stress event or factor might have on earnings or capital; and
  • incorporating the resulting analysis into the bank’s overall risk management process, asset/liability strategies, and strategic and capital planning processes.

 It is also clear that the OCC will expect the institutions that it regulates to stress test all call report categories, particularly focusing on concentrations of credit. To the extent that an institution’s stress testing reveals a scenario under which its capital ratios would fall below the level needed to support the bank’s overall risk profile (which we suggest would be viewed, at a minimum, to be the level required under the proposed Basel III capital rules), the institution’s board and management “should take appropriate steps to protect the bank from such an occurrence.” The guidance suggests some possible “appropriate steps,” and we suggest that the institution carefully document its responsive plan should it find itself falling below minimum capital requirements under a possible stressed scenario.

As we posted earlier in 2012, the regulatory agencies continue to focus on enterprise risk management practices for banks of all sizes. While the OCC is the first to introduce formal stress testing guidance for community banks, we believe that every agency will expect the board and management of institutions to understand the key risks facing the institution and to know how those risks affect the institution under a variety of scenarios. The OCC guidance provides some suggested stress testing approaches, and we commend those to community bankers as they develop and enhance their risk management and strategic planning processes. The creation of a customized enterprise risk management model and analysis that includes stress testing elements will please the regulators and, more importantly, better inform the decision-making of the board and management of the institution.