While the execution of robust model risk governance processes are critical for all financial institutions performing annual stress tests, in many cases, the successful delivery of DFAST 2016 results will depend on the institution’s ability to execute as a team and implement disciplined project management approaches.

While regulators have required banks to perform stress tests on their portfolios for years, the Dodd-Frank Act now requires an enterprise-wide simulation of an institution’s income statement, balance sheet and capital deployment over a 9-quarter forecast horizon. For banks with multiple, decentralized business lines, an enterprise-wide stress test presents challenges when attempting to aggregate an accurate, consolidated view across the entire banking organization.

DFAST has caused banks to develop processes that support the analysis of bank capital levels that require inputs from multiple business lines using complex processes that leave little room for error. Meeting this challenge depends on effective delivery from high-performance teams. The success of these teams requires successful management and integration of three critical organizational skills: 

  • People
  • Planning, and 
  • Process.

People: All high-performance teams start with clear goals and accountability. A clear delineation of roles and responsibilities for each team member should be identified and communicated.

In many cases, banking organizations which have successfully managed stress tests have created centralized teams responsible for overall project delivery. These centralized teams coordinate and reconcile the delivery of projects across the different business lines. While subject matter experts within business lines are leveraged to produce their inputs for Pre-Provision Net Revenue, Loss Provisions and Operational Risk losses, the centralized stress testing team takes a broader, top-down view to aggregate and reconcile information related to each scenario.

Planning: All high-performance teams spend significant time learning from their mistakes and developing plans to overcome past challenges. Teams responsible for the delivery of DFAST results should identify and study past shortcomings to develop and implement planned new processes. Each annual stress test cycle should begin with a comprehensive debrief of the previous year’s submission. Planning begins with the identification of the personnel, resources, and capabilities that will be employed to eliminate previous mistakes.

After processes to remediate “lessons learned” from previous stress tests have been identified, a comprehensive risk identification process should be completed. During the initial phase of the annual cycle, the project team should identify and document:

  • a risk inventory of the entire institution,
  • changes to strategic direction, and
  • changes in portfolio composition.

Risks identified during this phase can be used to begin development of “draft” narratives that discuss the risks posed to the institution, potential impacts on the institution’s capital, and a starting point for expected results of the capital planning process.

Process: World-class processes are created when team members have a clear, transparent description of the work being performed. With respect to annual stress tests it is imperative that a comprehensive view of the data, assumptions, and processes used to produce the institution’s stress test results be tracked from source to regulatory submission. An end-to-end view of the process, with identification of projected weak points, is needed to inform decisions by the centralized project team and senior management. Utilizing resources to document process flows and procedures will provide immediate benefits to controls and long-term benefits to the technology infrastructure supporting the capital planning process.

Once the end-to-end process needed to support stress testing has been documented, an organization should run “pre-game” drills to test and improve data, models, infrastructure, and reporting that support certain areas of the actual stress test process. Continually testing and improving the stress testing infrastructure will identify and remediate weaknesses and embed the capital planning process in an organization’s day-to-day capabilities.

Developing an organizational structure that leverages a centralized team with clearly defined roles, strong project planning experience, and process improvement expertise is key to establishing high-performance capabilities necessary for the capital planning process. The people, planning, and processes necessary to successfully navigate the annual stress test submissions, however, are often overlooked and not sufficiently coordinated. With so many institutions requiring input from multiple business lines within compressed time windows, the need for clear communication of schedule timelines, roles, and responsibilities has never been clearer.

For more information about this topic, contact:

Pat Greene, Senior Managing Director (pgreene@riskspan.com)