Global Association of Risk Professionals (GARP)’s Post

The Importance of Real-Time Stress Tests and Scenario Analysis for Asset Managers In today’s volatile market environment, real-time stress tests and scenario analysis have become indispensable tools for asset managers. While the Federal Reserve’s annual stress tests (see below GARP article) provide valuable insights into the resilience of the largest U.S. banks, asset managers must conduct their own tailored stress tests based on risk factors specific to their portfolios. This approach ensures that the needs and expectations of end investors are accurately targeted. For buy-side firms, performing these stress tests and scenario analyses enhances transparency and builds credibility. It allows them to demonstrate their ability to withstand adverse market conditions and manage risk effectively. Particularly for investors in Separately Managed Accounts (SMAs) and/or institutional portfolios, this practice provides assurance that their investments are being actively monitored and safeguarded against potential market disruptions. The need for real-time stress tests and scenario analysis has never been more critical. In the current environment, characterized by economic uncertainties, fluctuating interest rates, and evolving market dynamics, asset managers must be proactive in identifying and mitigating risks. These analyses enable asset managers to simulate various adverse scenarios and assess their potential impact on portfolio performance. This proactive risk management strategy not only protects the investments but also fosters greater confidence among investors. And by leveraging advanced risk analytics tools, asset managers can navigate the complexities of the current market environment and ensure the resilience and stability of their portfolios. Finally, a key point from the article below that is important - "Risk managers are advised to enhance stress testing infrastructure for better strategic planning and portfolio optimization." #marketrisk #stresstesting #businessintelligence #realtimeriskanalysis

The Fed's Stress Test result concluded the 31 banks within the scope have the capacity to absorb nearly $685 billion in losses and continue lending under stressful conditions similar to the GFC. The severely adverse scenario features a 36% decline in U.S. home prices, a 40% fall in CRE prices, a 55% drop in equity prices, and an unemployment rate of 10%. The aggregate CET1 capital ratio was estimated to fall from 12.7% to a projected minimum 9.9%, which was still more than double the required minimum regulatory level of 4.5%. With smaller regional and community banks holding a greater concentration of CRE loans on their portfolios relative to larger banks, CRE loan portfolios could pose to the broader financial system if defaults were to accelerate quickly; This is not fully captured by the stress testing since it only focuses on large banks. The New Exploratory Scenarios were performed by the Fed, the new testing includes two funding stress scenarios for all tested banks, including a rapid repricing of deposits, combined with both a severe and moderate recession and two trading book stresses applied to G-SIBs only, including the failure of five large hedge funds under different market conditions, the G-SIBs were projected to lose 1.0-1.2 % of their RWAs. In addition to future earnings uncertainty, banks are subjected to potential regulatory changes on the horizon. With the proposed Basel III Endgame rules, the increased capital requirements would further reduce the largest banks' CET1 ratio and the resulting increase of lending costs. check the details of the scenarios, methodologies and results at: https://lnkd.in/g5EjPEPv

The Fed’s 2024 Stress Test: Key Takeaways The good news is that the commercial real estate market is not projected to crater and that large U.S. banks have enough capital to survive another massive crisis. The bad news is that CRE lenders remain vulnerable, while there are worrying signs for corporate credit, default rates, loan performance and the economy.

This doesn't pass my own smell test, I am skeptical and doubtful that this is a valid assessment of the banks today...~r "The 31 large US banks that participated in a Federal Reserve stress test would all be able to withstand a severe global recession, a new demonstration of strength as they push back on stricter regulations that would require them to hold more capital. Results released by the Fed Wednesday show that these banks would have enough capital on hand to absorb losses and continue lending during a two-year scenario where US unemployment climbs to 10%, commercial real estate prices fall 40%, and the stock market plunges 55%." https://lnkd.in/gKEkMp6M?

Big U.S. banks pass Fed’s stress test All 31 of America’s biggest banks have passed the Federal Reserve’s annual stress tests. The stress test, which formally began in 2011 after the 2007/09 financial crisis, assesses whether banks could endure a severe recession in which unemployment rose to 10%. The scenario imagined by the Fed would see banks lose nearly $685bn. The total projected losses included $175bn in credit card losses, $142bn in losses from commercial and industrial loans, and nearly $80bn in losses from commercial real estate. Michael Barr, vice-chairman of supervision at the Fed, said the test “shows that large banks have sufficient capital to withstand a highly stressful scenario and meet their minimum capital ratios.” He noted that the goal of the test is to “help to ensure that banks have enough capital to absorb losses in a highly stressful scenario.” He added: “This test shows that they do.” Subscribe to Risk Channel now if you want to receive the most relevant #RiskNews directly to your inbox.👇 https://lnkd.in/gQeh9xuf #risk #riskmanagement #finance #banking #stresstest

This shows the adequacy of current capital levels as the 31 largest banks passed the stress tests. The scenario was to test the ability to keep operating for two years with 55% crash in the stock market, 40% drop in commercial real estate value, and 10% unemployment. The regulators who want to require more capital are wrong. Banks as a whole are better capitalized than ever. The requirement for higher capital would impair banks, hurt small businesses, consumers, and damage the economy.

𝗦&𝗣 𝗚𝗹𝗼𝗯𝗮𝗹 𝗱𝗼𝘄𝗻𝗴𝗿𝗮𝗱𝗲𝘀 𝗼𝘂𝘁𝗹𝗼𝗼𝗸𝘀 𝗼𝗻 𝗳𝗶𝘃𝗲 𝗿𝗲𝗴𝗶𝗼𝗻𝗮𝗹 𝗨𝗦 𝗯𝗮𝗻𝗸𝘀 𝗱𝘂𝗲 𝘁𝗼 𝘁𝗵𝗲𝗶𝗿 𝗰𝗼𝗺𝗺𝗲𝗿𝗰𝗶𝗮𝗹 𝗿𝗲𝗮𝗹 𝗲𝘀𝘁𝗮𝘁𝗲 𝗲𝘅𝗽𝗼𝘀𝘂𝗿𝗲𝘀 S&P Global downgrades outlooks on five regional US banks to 'negative' due to their commercial real estate (CRE) exposures, in a move likely to reignite investor concerns about the health of the sector. The ratings agency downgraded First Commonwealth Financial, M&T Bank, Synovus Financial, Trustmark and Valley National Bancorp to "negative" from "stable," it said. "The negative outlook revisions reflect the possibility that stress in CRE markets may hurt the asset quality and performance of the five banks, which have some of the highest exposures to CRE loans among banks we rate," S&P said. Source: Reuters https://lnkd.in/esYbV8A3

The Federal Reserve’s annual stress test showed all 31 of the largest U.S. banks are likely to withstand a severe economic downturn, stay above minimum capital requirements and maintain the ability to lend to consumers and corporations. Banks have built extra capital in recent years, which has been driven by the approaching Basel III endgame requirements and growth in Significant Risk Transfers – which we helped to pioneer – among other strategies.   In the hypothetical scenario, more losses compared to the previous year were observed across the board given factors like higher holdings of consumer credit card loans, a greater share of corporate bonds being downgraded and squeezed lending margins, but the ability to withstand a severe recession is a positive sign for the economy.   With the potential for continued volatility within the industry and evolving risks, our team actively monitors markets to understand how we can continue to provide our global, solutions-driven approach for partners and clients. https://lnkd.in/gKtJatzi

The performance of banks often serves as a barometer for the economy's health, reflecting how they adapt to changing environments. This article delves into the Q1 2024 performance of banks, examining charts for both large and small banks in lending and deposits to gauge their approach to the current market. By analyzing these trends, we can discern whether lending practices are tightening under stricter underwriting guidelines or becoming more lenient, indicating optimism about the future. Currently, it appears that banks are proactively responding to anticipated shifts in the market. This is merely my perspective on the matter.

DON'T MISS THIS ARTICLE... Although a decline in total volume suggests the overall need for excess cash has lessened, the spread between what borrowers at the highest percentile of the daily fed funds distribution have to pay and those below is at its widest since September 2019. That’s a sign that some smaller institutions are still having to pay more to borrow cash, according to Bank of America strategists Mark Cabana, CFA, and Katie Craig. “We believe it is likely the smaller domestic banks with more limited cash buffers that are driving this upward pressure,” the Bank of America strategists wrote in a note to clients. “Smaller banks have reported to us in the past that they value the fed funds market as a stable source to cover any unexpected short-term liquidity needs when their existing funding falls short.” The distribution of daily fed funds transactions published by the Federal Reserve Bank of New York shows that interest rates on overnight loans for the 99th percentile has climbed to 5.65%, which accounts for the latest hike. But the gap between the 99th and 75th percentiles has widened to 33 basis points, from near zero in March 2022 when the central bank began its hiking campaign and later quantitative tightening. The strategists noted that bank call reports show domestic institutions shifting to net borrowers of fed funds from net lenders at the beginning of quantitative tightening. That suggests that liquidity pressure is likely to continue as the balance-sheet unwind continues for the foreseeable future, Cabana and Craig wrote. The benchmark rate rose to 5.33% on July 26, according to data published Friday, which reflects the central bank’s latest action. #INVESTMENTBANKING #HEDGEFUNDS #PORTFOLIOMANAGMENT #CEOS #CIOS #CFO #CFOS #CIO #ASSETMANAGEMENT #FED #INFLATION #ECONOMY #EUROPE #ASIAPACIFIC #MARKETS #COMMODITIES #ECONOMICS #PRIVATEEQUITY #MONEY #VENTURECAPITAL #INVESTING #BANKINGINDUSTRY #TREASURY #STOCKMARKET