THE CASE FOR STRESS TESTING MORE FREQUENTLY By Matt Helsing SVP and Northwest Regional Manager, PCBB, ICBC Associate Member Like other financial providers, some banks perform annual stress tests that are designed to see how the institution would fare under various economic scenarios, from a moderate downturn to the most severe hypothetical shockwave. Some community banks aren’t required to perform annual stress tests. However, if there is one thing the financial industry has learned from the recent bank failures, it’s that stress can arise suddenly, especially in a rapidly changing market environment. Now more than ever, it’s crucial for your management team to have tools on hand that can help you be both proactive and responsive in the face of any other challenges that arise within the industry. As a management tool, stress tests help executives identify any potential flaws in their current plans and practices and also help your team brainstorm and even test solutions. WHAT SHOULD A STRESS TEST COVER? Every community bank is a little different, and its executives are the best judges of what is mission-critical. In general, however, you should ensure that your organization can: • Maintain capital reserves sufficient to absorb severe losses. • Keep capital above the minimum requirement. • Continue lending — the backbone of most community banks’ business. WHAT ARE THE POTENTIAL BENEFITS OF STRESS TESTING MORE OFTEN? Even if not required, all institutions can benefit from stress tests. After all, the purpose of stress testing is to ensure your organization can withstand changing economic conditions. The market has been volatile and often unpredictable in the past few years, proving that your organization may not be able to see every change coming down the pipeline that will affect your capital and earnings. Given how quickly these events have happened, stress testing can allow your organization to plot out and anticipate any scenario you can fathom. If you stress test for these potentialities as the market changes, you’ll have time to assess weaknesses in your portfolio and address them, just in case a hypothetical situation becomes a reality. It’s far better for your staff, your customers, and your community if you can hash out a plan ahead of time for a scenario than to have to discover and deal with any challenges in real-time when your business is already being impacted. Stress testing can also indirectly help you with your strategic planning, business continuity plans, and various other aspects of your institution that could be affected in each scenario. For most financial institutions, ensuring that most essential processes can continue even if economic conditions worsen means managing lending concentrations. Given the increased uncertainty in commercial real estate (CRE), and trends in remote work, it makes sense for some community banks to pay particular attention to the potential effects of different future scenarios on CRE lending. For example, a community bank that holds commercial loans secured by office properties may consider a higher vacancy rate, as we expect that some tenants may not renew their leases at the same square footage (or at all). 30 | INDEPENDENT REPORT
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