Interview with David Buck, Head of Integrated Stress Testing & Forecasting, Citizens Financial Group
As banks struggle to keep pace with regulatory updates while meeting capital requirements, there is a great desire to improve efficiencies so more focus can be placed on growth and profitability. Regulators have made it clear that risk management should be the centerpiece of banks’ strategic business plans, and many institutions are transitioning their processes to reflect this mindset.
David Buck, Head of Integrated Stress Testing & Forecasting at Citizens Financial Group, recently spoke with marcus evans about results and analytics for risk appetite:
What are some ways to leverage stress testing in aligning risk management and strategic decision making?
DB: While stress testing, particularly regulatory stress testing, is often viewed as a burden, there are many ways it can be a productive experience. If you are willing to absorb stress testing into your planning process, it can even drive evolution in other processes for strategic benefit. I’ve no doubt that institutions have widely varied practices in this space but I am happy to share how we’ve been working through this process.
One way is through defining your institution’s risk appetite. Various scenarios processed through stress testing provide different insights. Assessing the results of an adverse scenario (defined as a relatively cyclical economic downturn) will give an indication of how your institution fares in terms of income, losses and capital position. At the institutional level, these results can be assessed against the institution’s risk appetite. This appetite, perhaps only defined as a preferred Moody’s/S&P rating, now has a level of performance associated with it. Credit, Market and Operational losses can be associated with this level of appetite. As future scenarios are processed, similar measures can be compared to provide some confidence around this appetite of risks. As the process evolves, losses across risk categories can be assessed at divisional or product levels, offering possible risk appetite thresholds which can be monitored and measured over time.
Similarly, multiple strategies can be assessed across scenarios to understand potential impacts. It’s no surprise that strategies appearing profitable in good times could quickly erode, should the economy take a turn for the worse; however not all strategies have the same sensitivities. As a matter of fact, some strategies may have resilience in certain downturns that make them even more advantageous. Through stress testing, these behaviors can be better understood and provide management with useful information as they assess which strategies are deserving of capital support.
You will be participating in a panel discussion that provides dialogue around lessons learned in CCAR implementation – What are some of your lessons learned (the good, the bad or the ugly)?
DB: I think in this cycle, we really experienced the importance of process. With high capital levels and a ‘survivor-biased’ loan profile, the last couple stress tests have shown that it seems to be less about the quantitative aspects and more about the qualitative; it's about your ability to do the work, and do it effectively and efficiently. It's about establishing a process and managing the handoffs and timelines within it. When you have that established, heightened focus can be placed on the analysis.
I think all institutions have learned this one, but it's the most difficult to adhere to; you have to document your assumptions. I’m sure many institutions have learned that if it’s not documented, it didn't happen...or at least you can't show it to the regulators, or to internal audit for that matter. The difficulty is how to document all your assumptions and work in a digestible way. I can see this aspect going through many evolutions as institutions work to make the submissions as clear and concise as possible.
Related to this last comment is internal communication. Poor communication between business lines and the stress testing group, for example, could result in new products and/or strategies planned for the near future being excluded from your submission. The stress testing group has to be communicating regularly with the lines of business (and your budgeting/planning groups) to ensure the stress test doesn't result in material differences/inconsistencies in the near term.
What are a few peaks and pitfalls you have discovered in applying scenario analysis and sensitivity analysis to determine emerging risks?
DB: I think the most obvious is data. Depending on the risk you are attempting to assess, you may not have a good 'model' for how this risk will manifest in a given scenario; and even if you do, how do you approximate correlations with other variables? Understanding the drivers of your exposures will help identify what variables you know to care about; assessing them at various levels of stress will provide sensitivities. This leaves a few other important aspects to tackle; unknown drivers and the impacts of correlation.
Historical analysis helps identify drivers of portfolio performance but only backwards-looking. Other drivers could be out there, but they haven't shown up yet. Through the modeling process, discussions with the front line can help bring these to the table. Applying some expert judgment can gauge the priority of incorporating these into stress scenarios.
Correlations can be viewed the same way. Historical data may not capture the potential 'breaks' that occur under a particular set of stress conditions. There are many 'severely adverse' scenarios and no two would likely have the same set of correlations. Testing the correlations, and not just the levels, of your portfolio drivers will help identify these hidden emerging risks.
Prior to his current role as Director of Capital Strategies and Analytics, David led the Integrated Stress Testing group at Citizens. He joined Citizens in 2014 with almost 20 years of risk and capital experience with financial institutions through consulting, regulatory and practitioner roles with KPMG, QRM, the Federal Reserve Bank of Chicago and GE Capital. He also holds an MBA (econometrics and statistics) from the University of Chicago’s Graduate School of Business.
Join David at the 10th Annual Capital Allocation & Stress Testing Conference, July 27-28, 2016 in New York City, NY. For more information, take a look at the conference agenda or contact Tyler Kelch, Digital Marketing Manager, marcus evans at 312.894.6310 or Tylerke@marcusevansch.com.
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