Pub. 6 2011-2012 Issue 3

www.nebankers.org 18 Extraordinary Service for Extraordinary Members. share risk in the manner prescribed by Dodd-Frank, banks should expect sponsors to take steps to transfer the cost of risk exposure by paying bank lenders less for the non-QA they sell. Stress Testing Recently, the federal agencies published proposed guid- ance (the “Proposed Guidance”) on stress testing for de- pository banks or bank holding companies (each, a “banking organization”) withmore than $10 billion in total consolidat- ed assets. The Proposed Guidance highlights the importance of stress testing as an ongoing risk management practice, which supports a banking organization’s forward-looking assessment of its risks. Further, it also discusses the impor- tance of stress testing in capital and liquidity planning, and the importance of strong internal governance and controls in an effective stress testing framework. In the context of the advanced approach to determining risk levels, stress testing gives banking organizations insight into the point at which such banking organization’s operational risk model stops working or stops giving the banking organization reasonable results. Federal banking agencies have previously highlighted the use of stress testing as a means to better understand the range of a banking organization’s potential risk exposures. 9 The Proposed Guidance, however, fails to explicitly address the stress testing requirements imposed upon certain bank- ing organizations by Section 165 (i) of Dodd-Frank, although the federal agencies have indicated they expect to implement those provisions in a future rulemaking consistent with the principles in the Proposed Guidance. Under the Proposed Guidance, a covered banking organization is expected to develop and implement “an effective stress testing framework as part of its broader risk management and governance processes.” The uses of a bank’s stress testing framework is expected to include, but not be limited to: (i) augmenting risk identification and measurement; (ii) estimating business-line revenues and losses and informing business-line strategies; (iii) identifying vulnerabilities and assessing their potential impact; (iv) assessing capital adequacy and enhancing capital planning; (v) assessing liquidity adequacy and informing contingency funding plans; (vi) contributing to strategic planning; (vii) enabling senior management to better integrate strategy, risk management, and capital and liquidity planning decisions; and (viii) assisting with recovery planning. The Proposed Guidance also outlines four principles for a stress testing framework. Principle 1 —a banking organization’s stress testing frame- work should include activities and exercises that are tailored Q Capital Confusion? — continued