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1. navigant.comF I N A N C I A L S E R V I C E S F i n a n c i a l R i s k M a n a g e m e n t Stress testing has long been an integral part of risk management. Prior to…
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  • 1. navigant.comF I N A N C I A L S E R V I C E S F i n a n c i a l R i s k M a n a g e m e n t Stress testing has long been an integral part of risk management. Prior to the recent credit crisis, bank stress testing programs typically involved the development of scenarios that mimicked the impact of events such as the Russian debt crisis and Long-Term Capital Management’s failure. Post-financial crisis, more stringent regulatory guidelines surrounding capital and liquidity standards have necessitated a complete overhaul of bank stress testing programs. The Dodd-Frank Wall Street Reform Act of 2010, among other mandates, requires financial institutions to assess the capital needed in order to weather a steadily deteriorating economy or sudden economic shock. The primary goal of the stricter stress test and capital plan rules is to spur a significant improvement in the internal infrastructure, planning, risk, and forecasting capabilities of financial organizations. While the requirements, at least for the initial assessment date in March 2014, are less onerous for banks with $10 to $50 billion in assets, the underlying principles described in greater detail below apply to all firms. STRESS TESTING & CAPITAL PLANNING
  • 2. e x p e c t EXPERT GUIDANCE FUNDAMENTAL PRINCIPLES PER THE GUIDANCE INCLUDE: Principle 1: A banking organization’s stress testing framework should include activities and exercises that are tailored to and sufficiently capture the banking organization’s exposures, activities, and risks. Principle 2: An effective stress testing framework employs multiple conceptually sound stress testing activities and approaches. Principle 3: An effective stress testing framework is forward-looking and flexible. Principle 4: An organization’s stress testing environment should have a robust process for bringing together estimates of losses and capital adequacy in relation to the organization’s stated goals for the level and composition of capital. Principle 5: Stress test results should be clear, actionable, and well-supported and should inform decision-making. Principle 6: An organization’s stress testing framework should include strong governance and effective internal controls. HOW NAVIGANT CAN HELP YOU Navigant’s risk management professionals have deep expertise in the areas of credit risk, market risk, and operations risk. We have the resources and technology needed to provide the following services to assist our clients in meeting their stress testing and capital planning requirements. Risk Identification – Navigant can conduct a diagnostic review of existing processes and provide recommendations on the purpose and scope of the stress test, data requirements, appropriate stress testing techniques, and the technology needed for implementation. Scenario Analysis – In addition to the stress scenarios (baseline, adverse, and severely adverse) required by the Federal Reserve, it is important for an institution to run its own scenarios based on the risk assessment of its portfolio. Navigant can assist in designing scenarios that assess the amount of capital and liquidity needed to support the business activities of financial institution such that, preferably, economic and regulatory capital and liquidity are less than the required regulatory minimum and the difference between the bank’s calculated amount and the required amount is minimal.
  • 3. e x p e c t RESULTS Loss Projection – Navigant can assist with capturing the behavioral characteristics of the loan portfolio so that asset-level losses are modeled accurately. Additionally, Navigant can facilitate the integration of asset-level loss projections into net interest income projections. Data Warehouse / Data Quality /Integrity – Navigant has deep expertise in data readiness review. Different business units within an organization have different ways of capturing data. Therefore, it is very important to have a thorough understanding of data quality issues and any data gaps that may exist before conducting stress tests. As a specific example, Navigant is very well-versed in different ALM systems (which may be used to create a pro-forma income statement) and will ensure consistent inputs from the credit, finance, and other risk functions of the bank are being used. Enhancing data sourcing and storing capabilities where necessary is also our core competency. Model Validation – To comply with regulatory requirements, all high risk models of a financial institution must be independently validated. Navigant has deep expertise in modeling applications used in all areas of risk management and we have helped set up model validation policies and procedures at various financial institutions. Technology – Stress testing is not a one-time exercise. Proper processes and automation must be in place in order to meet the periodic requirements emphasized by regulatory guidance. Some institutions choose to utilize third party tools to conduct stress testing. In the event an institution is inclined towards utilizing third party tools, a proper vendor selection process as well as robust implementation is needed. Navigant can assist by providing support in the following areas: »» Vendor Selection Process »» Business Requirements Development »» User Acceptance Testing »» Project Management
  • 4. ©2013 Navigant Consulting, Inc. All rights reserved. 00002615 Navigant Consulting is not a certified public accounting firm and does not provide audit, attest, or public accounting services. See navigant.com/licensing for a complete listing of private investigator licenses. KEY STEPS OF A BANK STRESS TESTING PROGRAM: PLANNING CREDIT RISK ANALYSIS PPNR LIQUIDITY & OPERATIONAL RISKS SCENARIO BUILDER CAPITAL ALLOCATION REGULATORY REPORTING »» Senior Management Involvement »» Data Gathering & Fill-in Gaps »» Roles & Responsibiliites »» Documentation & Governance »» Appropriate Set of Market Data »» Develop Scenarios »» Economical & Historical Relationship Analysis »» Parameterized Scenarios »» Estimate Loan Loss Across All Assets »» OTTI Analysis »» Pro-Forma Balance Sheet »» Pro-Forma Income Statement »» Other Losses Including Ops Risk »» Charge-Off & ALLL »» Forecast Capital Position »» Transparent Contingency Plan »» Calculate NIR & NIE »» Populate Regulatory Report »» Reconcile & Evaluate the Results ABOUT NAVIGANT Navigant (NYSE: NCI) is a specialized, global expert services firm dedicated to assisting clients in creating and protecting value in the face of critical business risks and opportunities. Through senior level engagement with clients, Navigant professionals combine technical expertise in Disputes and Investigations, Economics, Financial Advisory and Management Consulting, with business pragmatism in the highly regulated Construction, Energy, Financial Services and Healthcare industries to support clients in addressing their most critical business needs. More information about Navigant can be found at navigant.com. CONTACT SUDIP CHATTERJEE Director 646.2227.4301 sudip.chatterjee@ncacf.com RAMAN MANDAPAKA Director 202.973.6572 raman.mandapaka@navigant.com PAUL NORING Managing Director 202.973.6550 pnoring@navigant.com TARIQ HUSSAIN Director 312.583.2133 tariq.hussain@navigant.com
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