The Virtues of Stress Testing
Bankers don’t often praise bank regulations.
So, I was surprised when Steven Hunter, director of strategic modeling at South State Corp., a $38 billion bank based in Winter Haven, Florida, praised the motivations behind the rules that forced his bank to implement stress testing.
“It felt like a regulatory burden,” he says. “But in hindsight, it was probably prudent risk management.”
Not long ago, banks above $10 billion in assets were required to conduct yearly stress tests that called for a substantial commitment of time and money. The recent regulatory rollback changed that; it now applies only to much larger banks.
CenterState Bank Corp., which completed a merger of equals with South State earlier this year, was caught in the middle of that transition. It was preparing for the rigor of mandated stress tests when that regulatory relief came.
Instead of abandoning all that work, the management team updated it to reflect the combined bank’s risk profile. It’s in good company: Bank Director found
that 94% of banks above $10 billion conduct a stress test; the majority of banks below that asset threshold do as well.
“We were able to take those tools we learned and scaled up for, and apply them to our balance sheet, using management sentiment,” Hunter says. “Regulators can only tailor the scenarios so much to each institution — we know our balance sheets better than anyone.”
Now, economic fallout from the pandemic has led the bank to regularly conduct “full-blown scenario analyses.”
Management runs multiple models each month designed to assess the interconnectedness between the economy and the bank’s balance sheet and earnings. They use multiple economic forecasts to examine how credit, liquidity and earnings change over time, manipulating noninterest income and noninterest expense to anticipate how economic trends may impact the bank.
“Management understanding the varying degrees of risk and how the balance sheet is going to perform under that scenario helps them be better positioned in figuring out how to make decisions through a crisis,” Hunter says.
“We’ve carried forward capital stress-testing practices into [the current expected credit loss standard, or CECL] because the data was there,” he continues. “I couldn’t imagine adopting CECL without having gone through capital stress testing first.”
• Kiah Lau Haslett / managing editor of Bank Director