The basics of CCAR stress testing

What is CCAR stress testing?

If you work in the world of U.S. banking and finance, or your goal is to do so, it’s important that you are up-to-date on at least the basics of mandated capital stress testing, particularly the annual Comprehensive Capital Analysis & Review (CCAR) stress test. This is a topic that could very easily come up during any job interview with a financial services firm.

Managed by the Federal Reserve (Fed), CCAR modeling came about after the economic collapse of 2008. The Dodd-Frank Act was enacted, which requires both the Fed and all large bank holding companies (any banking organization with consolidated assets of $10 billion or more) to conduct and submit the CCAR results of the annual test - then disclose those results to the public.

“The CCAR models were the key factor in recruitment in 2014. Some banks failed the test, or realized they lacked the staff necessary to pass. Consequently, hiring CCAR specialists became an urgent requirement,” says Robert Moseman, manager of the banking & FS division at Robert Walters New York.

CCAR scenarios are submitted according to macroeconomic scenarios provided by the Fed, and are used as protection to check for whether a bank’s system could theoretically handle a future economic shock. They test the bank’s ability to remain “well-capitalized,” with a minimum Tier 1 common equity ratio of 5 percent, even in a severely negative economic scenario. That hypothetical future scenario is supplied annually by the Fed to the banks so they can submit their responsive plans.

Under the rules of the CCAR regulatory exam, every mandated bank must submit a “capital action plan” for the following four quarters. The Fed then assesses that bank’s financial health and gives the bank a score. This score is not simply a “pass/fail”; banks are assessed in terms of exactly how strong they are. The Fed looks at whether or not banking organization have sufficient capital available to operate soundly even under extreme economic duress, and whether or not they have what the Fed calls “a robust, forward-looking capital-planning process that accounts for their unique risks.”

CCAR testing involves three main areas:

• Data
• Supervisory exercises
• CCAR requirements

The Fed coordinates the testing of these areas and evaluates each banking organization on its capital adequacy, internal capital adequacy assessment processes, and individual plans.

Generally, after the CCAR and other bank stress test requirements are announced (usually in March), most of the banks held subject will follow up the test result announcements with their own announcements about plans to deploy excess capital through the next four quarters. Usually, this capital deployment comes in the form of dividend increases and share buybacks.

Robert Moseman continues: “Most of the big banks have been reducing their count of outstanding shares through buybacks over the past few years, which boosts earnings-per-share, supporting higher stock prices.”

The stress testing process is meant to reassure the banking public that, were the economy to melt down again, their dollars would be well protected. Therefore, it’s not just a legal mandate for banks, but an important PR strategy. This is why CCAR news is so important to keep up with.

To further understand the importance of CCAR, it’s crucial to delve into its history. The CCAR was introduced as a response to the financial crisis of 2008, when many banks found themselves undercapitalized and unable to withstand the economic downturn. The CCAR was designed to ensure that banks have enough capital to continue operations throughout economic downturns.

The CCAR is not just a regulatory requirement, but also a strategic tool for banks. It allows them to assess their capital adequacy under various scenarios, and plan their capital actions accordingly. This includes decisions about dividend payments, share buybacks, and other capital distributions.

The CCAR also has significant implications for the job market in the financial sector. With the introduction of CCAR, there has been a surge in demand for professionals skilled in risk management, data analysis, and stress testing. These CCAR specialists play a crucial role in helping banks navigate the CCAR process and meet regulatory requirements.

In conclusion, the CCAR is a critical component of the U.S. banking system, ensuring the stability and resilience of banks in the face of economic shocks. Whether you’re a banking professional, a job seeker in the financial sector, or simply an interested observer, staying informed about the CCAR is essential.

As regulatory frameworks like CCAR continue to evolve, professionals with deep understanding of capital planning and risk functions remain in high demand across the financial services sector. For those looking to explore the next step in their finance career, we offer a range of opportunities tailored to your expertise.