Streamlining Ops & Capital: Why Banks are Rethinking the Value of Stress Tests

Preparing fore stress testsTalk of “regtech” may be getting louder, but stress-testing data and technologies can be applied beyond mere compliance in financial services

Regulatory “challenges.” Regulatory “burdens.” Regulatory “chores.” Ever notice that when organizations or industries talk about their compliance requirements it’s often in the most negative way possible? Even recent news about the U.S. fed dropping the qualitative requirements of its Comprehensive Capital Analysis & Review (CCAR) stress tests has roundly been described as “relief” for “exasperated” executives at the country’s largest banks.

Maybe we need to rethink our vocabulary, especially when doing the right thing is often described as a necessary evil rather than something that could benefit everyone involved.

In a recent article published in American Banker (subscription required), I highlighted how SaaS tools are quickly becoming a way for banks not only to get ahead of regulatory stress test requirements, but to streamline operations and improve how they manage their capital. This was echoed by Eric Byunn, partner at Centana Growth Partners, a private equity firm and Vena investor that specializes in finserv, fintech and other firms in what it calls the financial ecosystem. In the same article, Eric pointed out the basic challenge of gathering holistic compliance information quickly, accurately and easily:

“We had a couple of specific conversations with large U.S.-based banks, and they expressed a need to do regulatory reporting in a way that could draw upon many different parts of the bank with the ability to turn that information over to whoever their requesting regulatory authority is.”

Eric Byunn, Centana Growth Partners

While banks routinely brace for stress-testing, for example, and “regtech” has emerged as a rising category within the software sector, the most successful business decision-makers may wind up being those who see the tools and rules involved more as opportunities than unpleasant but inevitable priorities.

Lessons from Early Adopters

Stress tests: Lessons from early adoptersAshley Stengel, head of business performance and lead for financial planning and analysis at Great Western Bank in Sioux Falls, S.D., is an example of the changes underway in major organizations. She said it’s not just a matter of getting a passing grade once you’ve prepared submissions for CCAR, DFAST and the like, but using that effort to identify opportunities for business value.

“When we pull different tests using this technology, that’s the starting point for capital planning,” Stengel said. Her colleague and CIO, Scott Erkonen, added that the work to achieve compliance often results in the consolidation of information that has traditionally been stuck in silos.

“That real-time updating is a tremendous advantage to us — instead of having to work in a system where we have to wait for overnight runs or some sort of batch processing,” he added.

Great Western isn’t alone. According to a report last year from Grant Thornton, 78% of surveyed banks said the cost of preparing for stress tests is “very high or high.”

This is on top of what they need to allocate for M&A and other business activities.

“As a result, (banks) are challenged to deliver strong returns to their shareholders and require superior productivity throughout their organizations, including in regulatory compliance,” the Grant Thornton report said, adding that beyond lowering those costs, those who use regtech strategically discover that compliance can be a means to other ends within an organization:

"The application of data analytics is foundational . . . banks gain the ability to evaluate risks in real time by embedding big data and risk analytics into revenue-generating activities."

Grant Thornton: Is RegTech the future of compliance?

Stress Testing in Transition

This shift in thinking is coming at a time when longstanding criticisms of stress-testing in banking are not only being heard, but potentially leading to major changes. As Reuters recently reported, for example, the Federal Reserve plans to host a conference this summer that will examine the effectiveness of stress testing and look for areas of improvement. Translation: expect further “relief” from existing stress testing regulations.

Earlier in January, the Fed also proposed a rule that would eliminate the “adverse” scenario from the test and allow firms with an asset threshold above $250 billion to conduct company-run stress tests once every other year, rather than annually.

Let’s be clear, though: banks will still have to demonstrate they have the capital they need in the event of a crisis, and that they are using that capital as efficiently as they can. As a recent post on Bank Policy Institute pointed out, upcoming regulations like Current Expected Credit Loss (CECL) could significantly increase compliance costs if they are incorporated in stress tests under the assumption of perfect foresight. The need for the right tools -- and a strategic approach to gathering and analyzing the necessary information to satisfy regulators -- is not going away.

True leadership, however, will align regulatory requirements with outcomes that contribute to the overall success of the business. That’s why experts from McKinsey actually recommend even non-financial organizations should conduct their own stress tests:

"The usefulness of risk-measurement exercises can be limited if they aren’t dynamically linked to strategic planning, capital allocation, and other business decisions. That means such exercises need to include more than just a CFO or a board audit committee . . . or they amount to little more than a “tick-box exercise” that fails to change behaviors in the business."

McKinsey: Stress testing for nonfinancial companies

McKinsey argues such exercises can directly benefit shareholders and other stakeholders. But they also caution that doing so will undoubtedly demand more sophisticated ways of bringing data from across organizations into a single, cohesive view. A challenge, to be sure, but nothing finance departments haven’t seen before.  

Next Steps

While affected banks have many of the right technologies in place already, “regtech” as a category is starting to represent a dizzyingly broad array of applications. Consulting firm Deloitte has started what will be an ongoing list of regtech vendors that spans not only reporting but risk management, identity management & control, compliance and transaction monitoring.

This is the perfect time, in other words, for those leading compliance efforts in their organization to dive deeper into what’s available and what may soon become mission critical, both for stress testing as well as desire to have the analytics to support buybacks and other capital-oriented decisions.

Some factors to keep in mind include:

How Can You Minimize Business Disruption? While the end result of stress tests could offer organizations greater reporting agility, a centralized view of data and other benefits, it shouldn’t come at the expense of tying up resources that are needed to serve day-to-day objectives. Consider where the technology can assist in accelerating processes and reducing time-consuming complexity.

What Will Decision Making Look Like? Stress tests provide assurance to regulators, but you also want to ensure regtech tools make it easy to surface actionable insights for business leaders beyond compliance. Look for approaches that allow a deeper look into granular areas and the ability to accommodate ad-hoc requests – particularly in managing capital and liquidity.

How Quickly Can Your Model Be Recalibrated? The variables banks consider as part of stress tests are often based on historical information. In the “real world,” the models an organization use may have to consider more specific factors in order to avoid a crisis.

When (and How) Will We Need to Look Back? The best governance and control methodologies ensure that organizations can justify the decisions made, whether in response to a stress test or to an actual business issue or crisis. Imagine the kind of post mortem you may need to conduct and how best to empower your stakeholders in an accessible and transparent way.

With market volatility a fact of life and changes in government positioning around stress testing happening more frequently, banks would do well to look more broadly at the application of related technology and data to strengthen their internal capabilities -- and 

About the Author

Don Mal

Don is Vena's founding CEO and the company's chief ambassador, a lead spokesperson, advisor and advocate for the company on industry matters, business strategy and key customer relationships. Prior to co-founding Vena, Don led the North American sales teams for Clarity Systems, an IBM Company. He then led global sales for Cognos FSR at IBM before co-founding Vena. Don holds an MBA from the Rotman School of Management and a Master’s Certificate in Project Management from the Schulich School of Business.

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