FRB Governor Tarullo Offers Retrospective and Perspective on Supervisory Stress Testing

In remarks delivered to the FRB’s Third Annual Stress Test Modeling Symposium FRB Governor Daniel K. Tarullo focused on the “qualitative assessment of [large] firms’ capital planning processes” that the FRB conducts “in parallel with [its] quantitative assessment” and offered a “retrospective on the first five years of supervisory stress testing.”

Governor Tarullo noted that while the FRB’s “basic approach to stress testing has not changed materially” since the establishment of the Supervisory Capital Assessment Program, that several things have changed.  For instance: (i) the Dodd-Frank Act made stress testing a statutory requirement; (ii) the annual supervisory stress tests have been incorporated into the Comprehensive Capital Analysis and Review (“CCAR”), which requires large firms to submit an annual capital plan; and (iii) “substantial enhancements” to the supervisory stress test have occurred (including the development of independent supervisory models… [that] have increased [the FRB’s] ability to distinguish risks within portfolios.”  The FRB has through these adjustments developed stress testing into a key year-round element of the FRB’s supervisory program for large banking organizations.

Governor Tarullo highlighted the CCAR, stating that through it, the FRB has “sought to ensure not only that all large BHCs have strong capital positions as determined through our supervisory stress test, but also that they have strong capital planning practices that are appropriately focused on the capital needed to withstand possible losses from the specific risks in each firm’s business model.”  Govenor Tarullo opined that notable improvement has been made in firms’ capital planning processes (including “meaningful investments” in risk-measurement processes such as internal data and management information systems), but that additional improvement is necessary.  Governor Tarullo explained that that the “importance we attach to these risk-management and capital planning processes is reflected in the component of CCAR known as the qualitative assessment,” and that the FRB’s attention has shifted to that component of the CCAR.  The qualitative assessment “covers a range of topics, including the extent to which the design of a firm’s internal scenario captures the specific risks from the firm’s activities, the firm’s methods for projecting losses under stress scenarios, and how the firm identifies appropriate capital levels and plans for distributions.”