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STRESS TESTING: 8 FACTS EVERY

BANKER SHOULD KNOW

By the RMA Credit Risk Council

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1. STRESS TEST EVEN IF YOU DON’T HAVE TO

Federal regulations

require the largest

banks to undergo

stress tests.

However, stress

testing has become

a best practice and

an essential

component of risk

management

strategies

regardless of an

institution’s size.

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2. USE STRESS TESTING AS AN ESSENTIAL

COMPONENT OF RISK MANAGEMENT

Stress testing is an important tool.

It helps you better understand

risks in your loan portfolios and in

individual credit.

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3. YOU CAN’T BUILD A PERFECT MODEL

No model can perfectly forecast

how portfolios or individual

loans would perform under

specific conditions.

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4. GOOD STRESS TESTING MODELS

EMPOWER YOU

Gives you a general range of potential outcomes.

Informs you about portfolio or loan decision-making.

Allows you to structure portfolios/individual loans to

better withstand future stressed conditions.

Allows you to potentially avoid concentrations that result in unmanageable

asset bubbles.

A Good Stress Testing

Process

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5. BENCHMARK TO MAKE

STRESS TESTING USEFUL

Stress testing is most useful when it

is associated with well-defined

thresholds or benchmarks that allow

management and directors to prevent

portfolios from potentially materially

affecting earnings or eating into

capital.

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6. YOU CAN STRESS TEST AT MANY LEVELS

Various techniques are used for stress testing.

They range from:

The highly

quantitative

models used in

CCAR/DFAST

To loan-level

sensitivity analyses

performed at the

time of underwriting

and throughout the

life cycle of a credit

facility.

To simply

discussing

“what if” scenarios

with customers.

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7. YOU HAVE OPTIONS WHEN IT COMES TO

STRESS TESTING TOOLS

Build stress testing

tools in-house.

Purchase stress

testing tools from

vendors.

Options:

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8. CREATE GOOD

STRESS TESTING GOVERNANCE

It is

important

that:

• All members of the credit and risk

organization consider how

individual loans and portfolios of

loans could be affected by adverse

conditions.

• The business, credit, and risk sides

of the house coordinate model

management to avoid duplication

and unapproved model design and

development.

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8. CREATE GOOD

STRESS TESTING GOVERNANCE (CONT.)

Therefore,

management

needs to

create

governance

around stress

testing that:

• Allows for thoughtful consideration of

possible stressed scenarios.

• Allows for effective challenge of stress

testing methodologies.

• Ensures that actions informed by stress

testing are carried out in a consistent

manner across the organization.

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The Credit Risk Council supports

professionals who are responsible for

establishing, maintaining, or carrying out

credit risk management policies.

The council focuses on funded and off-

balance sheet risk management, including

capital markets activity, and other forms of

credit intermediation and risk mitigation.

About RMA’s Credit Risk Council

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Visit http://www.rmahq.org for information on risk management

RMA is a member-driven professional association whose sole purpose is to

advance sound risk principles in the financial services industry.

RMA helps its members use sound risk principles to improve institutional

performance and financial stability, and enhance the risk competency of

individuals through information, education, peer sharing, and networking.

Become a member today.