Washington, D.C.—The Conference of State Bank Supervisors (CSBS) issued a white paper advocating for community banks to utilize stress testing to evaluate the potential impact of key risk factors. In the white paper, CSBS calls for stress testing to be an industry-driven initiative. Conducting stress tests will help bank management better understand their institution’s risk profile and vulnerabilities, and should be accompanied by standards and best practices to define risk parameters, appropriate applications, and limitations.
CSBS developed the white paper in an attempt to spark dialogue among industry participants, policymakers and regulators on the benefits to be had from conducting stress tests at community banks. The community banking system was considered very well capitalized before the recent recession, but is now suffering from lack of capital and liquidity. To mitigate the negative impacts of future economic crises, community banks should be more cognizant of their vulnerabilities to an economic downturn or other stress events.
“The policies and standards around stress testing should be driven by the industry to ensure it becomes part of the risk management framework and not a regulatory exercise,” said Michael Stevens, CSBS Senior Vice President of Regulatory Policy. “Risk management needs to become more comprehensive and forward looking, not only to enhance the stability of the financial system but to protect the viability of the community banking model.”
The white paper also advocates for regulators to evaluate the results of any stress tests and bank management’s plans for mitigating risk, but a bank should not be subject to criticism for identifying its vulnerability. Doing so would undermine the stress tests and provide incentives for bank management to conduct less-effective stress test scenarios.
The white paper can be viewed in its entirety here.