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On June 26, the Federal Reserve Board released its annual bank stress test, which showed that while large banks would endure greater losses than a year prior, they are well-positioned to weather a severe recession and stay above minimum capital requirements.
The Board’s stress test, which covered 31 banks, is one tool to help ensure that large banks can support the economy during downturns. The test evaluates the resilience of large banks by estimating their capital levels, losses, revenue and expenses under a single hypothetical recession and financial market shock. The results from the stress test inform a bank’s capital requirements to help ensure a bank could survive a severe recession and financial market shock.
“The goal of our test is to help to ensure that banks have enough capital to absorb losses in a highly stressful scenario,” said FRB Vice Chair for Supervision Michael S. Barr.
Large global banks began using internal stress tests around the early 1990s; by the late 2000s that was moving toward regulatory mandate, a shift that accelerated in the wake of the 2008-09 global financial crisis.
Stress tests are now generally considered necessary for banks and trading firms with capital at risk.
“A stress test is a good exercise to help you and your team understand your positions and make decisions about whether to keep moving forward with what you have in place or make changes to your portfolio,” Cargill Risk Management wrote in a blog post. “Recurring stress testing helps your team and company go through the paces of different financial scenarios to lead efforts towards proactive risk identification and action recommendations.”
Whereas stress testing was once conducted largely with manual processes, advanced technology and tools are what enables today’s real-time risk management.
Malcolm Warne, Head of Product for Nasdaq Risk Platform, addressed the stress testing specifically for energy and commodity firms in a recent blog post.
“In today’s rapidly changing and volatile energy and commodity markets, trading firms and commodity brokers must constantly assess the ongoing impacts to their business,” Warne wrote. “The portfolio margin system, while designed to protect against defaults, is not enough in some cases to prevent firms from going out of business.”
Warne cited three key aspects to a comprehensive stress testing framework that can enable risk managers to navigate extreme market events: pre-emptive, or “always on” stress testing that runs intraday across positions; real-time stress testing, which enables risk managers to make informed decisions during a market crisis; and post-crisis stress testing, which evolves over time in response to market crises.
“A robust stress testing framework is a must for today’s traders and brokers to maintain agility and responsiveness amid quick-moving markets and crises,” Warne wrote.
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