Stress Testing Myths and Realities

July 2014

Stress Testing Myths and Realities

There are four misconceptions about stress testing that plague the community bank market, Invictus Consulting Group’s senior partner Adam Mustafa said on a KPN webinar this month.

The myths:

  1. It’s required for all banks.
  2. It’s primarily an ERM exercise.
  3. It’s really an extension of a loan review.
  4. It’s driven by historical loss experience.

The reality is that stress testing is only required for banks with assets of $10 billion or more. But community banks that follow stress testing best practices can often better defend their capital ratios and strategic plans to regulators.

Mustafa also described stress testing best practices. Those include:

  1. Treat stress testing as a strategic planning exercise first and foremost.
  2. Use it to look at your loan portfolio in a dynamic and not a static way.
  3. Make sure it’s a forward-looking approach.
  4. Use it as the centerpiece of a capital plan.

Stress testing is the only way to calculate the amount of FreeCapital™ a bank has for discretionary purposes, such as acquisitions and dividends. The graphic below shows that a capital stress test gave the bank the equivalent of raising $8 million at no extra cost to the bank.

If you’d like to listen to the webinar “Stress Testing is FreeCapitalTM,” please contact George Callas for access.