What Should Business Analyst Know About Comprehensive Capital Analysis and Review?

Comprehensive Capital Assay and Review (CCAR) is a regulatory framework governed by the Federal Reserve to assess, regulate, and supervise large Us banks that are besides big to fail. The global economical crunch/subprime crisis/recession of 2008 resulted in the economic plummet of some of the largest banks in the United states. The authorities had to bail out financial institutions such every bit AIG and Fannie Mae.

CCAR is a set of requirements from regulators to oversee bank holding companies with average full assets of $50 billion. Requirements address uppercase adequacy, uppercase distribution, and capital letter planning process nether base and stress economical scenarios.

CCAR is a kind of stress testing steered by the Federal Reserve board. Supervisory stress tests are an integral part of prudential regulations beyond the number of banks' jurisdiction. The CCAR report provides a view on the industry facing economic risks, cyber risk, and emerging risks from fiscal technology companies every bit a whole and shows a comparison amidst different institutions.

Banking concern'due south should prioritize 4 key areas as mentioned beneath for effective capital plan, mistake gratuitous CCAR models, transparency and hazard heads up among stakeholders and Board members. Read Web log

So, what does the CCAR program evaluate?

A Do banking company holding companies (BHCs) pose an adequate capital ratio? - Every bit function of the annual CCAR review, the U.s. Federal body volition evaluate all U.s.-based banking company holding company's capital letter ratios. BHCs must be mindful well-nigh showing majuscule structure distribution in their residue sheets.

B Is capital structure stable given the various stress-test scenarios? - The Us Federal Reserve volition provide BHCs with various stress-examination scenarios. A stress examination is used for micro- and macro-level validation. BHCs will consider stress scenarios and evaluate the upper-case letter structure. The objective of the FED here is to make sure that BHCs have adequate capital during economic crisis to avoid bailout state of affairs.

C Are planned uppercase distributions feasible and acceptable? - Capital distributions such as dividends distribution to shareholders and share repurchase either from existing shareholders or from exchanges should be planned per regulatory minimum capital construction requirements. US-based BHCs must append planned majuscule distribution to shareholders (corporate action events) in scenarios where the current capital balance is in deficit or the capital structure fails to comply per FED standards.

Stress testing scenarios

Us Federal jurisdiction frames stress-testing scenarios and publishes them for BHCs every year. BHCs should consider these stress scenarios during capital assay and review. The Federal Reserve releases annual CCAR scenarios in Jan and BHCs are expected to submit their capital plans and stress tests based on scenarios in Apr. BHCs implement a quarterly plan from July which includes distribution of excess capital, dividend payments, and share buyback as declared in the majuscule activity plan.

Baseline scenario: It is a lightweight and ordinarily simple scenario based on boilerplate projections of economic forecasters. This scenario considers current market and economic trends without expecting much volatility.

Adverse scenario: This scenario is placed higher up the baseline scenario and is slightly complex. This hypothetical scenario considers a moderate recession or mild deflation that might have a short-term consequence on economy. An adverse scenario usually helps BHCs manage upper-case letter adequacy and plan meliorate to distribute majuscule during short-term fluctuations in the economy.

Severely adverse scenario: BHCs will have a tough time working on severely agin scenarios and this will requite a true picture of the depository financial institution'due south credibility to withstand long term economic system crisis. This scenario includes hypothetical situations involving a severe global recession in the US, unemployment rates rising to 10%, corporates struggling with inadequate finance, borrowing outside markets becoming impossible, and US treasury securities yielding negative returns.

Components of CCAR

A Stress testing - As a part of stress testing, BHCs clarify and submit detailed income and balance sheet projections. They submit three Fed-specific scenarios (discussed in a higher place) and 2 internal scenarios at year-end. Banks also consider global market daze scenario and largest counterparty default scenario where applicative, uppercase ratios are projected over nine quarter planning horizon.

B Capital plan - BHCs set upwards an internal meeting and finalize the decision on capital program/policy. Every bit part of their internal process, they discuss and assess capital capability, and documentation plays a crucial function here. Extensive capital letter programme and planned majuscule actions over nine quarters are extensively documented. Documents normally consist of thousands of pages which are further utilized for inspect and Fed regulatory purposes.

C Governance - BHCs accept a governance torso formed internally to make certain that each phase of CCAR is reviewed completely before reporting to FED. As part of governance, BHCs review a comprehensive stress testing framework, forth with documentation and model validation. Stress testing results are reviewed by board members. Capital plan is reviewed past an internal audit after validating required controls. The governance committee volition enhance questions on several occasions and have quality time to evaluate all phases of CCAR. Multiple meetings are conducted to review documents, models, and stress testing results. This is considered as one of the crucial components equally governance approval serves as a gate pass to farther report the banking company's capital plan and results.

D Reporting - BHCs prepare for reporting the capital letter programme and results post approval from the governance committee. FRY 14A regulatory reports are prepared and reconciled to the FRY 9c report, model inventory mapping are performed on FRY–xiv reports. Again, all-encompassing documentation is maintained outlining the BHC procedures for meeting the accurateness requirements of reporting forms.

CCAR challenges for banks

There is no doubt that CCAR-eligible banks take come a long way. Financial institutions accept implemented and enhanced their stress testing and majuscule planning process since its inception in 2009. This is evident from an increase in high-quality upper-case letter to risk-weighted assets of 34 BHCs which has doubled from v.5% in 2009 to 12% in 2017. However, the broad and technical nature of CCAR regulatory framework challenges the banks to effectively comply with regulatory requirements. Below are a few of them:

Data Quality and Integrity

Availability of the firm's key information for CCAR cess is inconsistent. Also, stringent timelines of the CCAR cycle challenge banks to provide quality information for submission. Firms follow an estimation approach for CCAR access. This might exist appropriate under expected weather but not suitable for stress testing.

Internal Controls

Regulators await CCAR banks to accept a robust internal regulatory framework. However, many BHCs confront challenges in remediating gaps in internal controls. Banks are expected to own, update, admit, certify, and validate internal controls.

Unskilled/Not-technical Teams

Unfortunately, only few individuals within a depository financial institution understand the CCAR regulatory requirements which delays model documentation and scenario pattern. Banks are trying to implement a mutual linguistic communication communicated beyond different business units and functions to achieve consistency.

Governance and Transparency

Financial institutions struggle to ensure transparency of process in lath meetings. Whatsoever gaps and limitations in capital planning must be discussed among board members prior to approval. The board must exist involved early in the CCAR bike to sympathise any identified risk associated with products that might impact stress testing.

Testament Enhancements

The Federal Reserve notifies shortfalls in the overall CCAR programme through annual CCAR results. In this regard, banks should consider integration and enhancement of CCAR. CFO testament is the terminal dominion of the overall CCAR programme. Banks should be mindful in considering attestation enhancement recommendations from the Fed and should implement in stringent timelines.

Hereafter perspective of the CCAR regulation

On June 27, the US FED published results for CCAR 2019. It was positive news for all 18 participating banks where their respective upper-case letter plans on qualitative and quantitative grounds was approved. While banks have seen some reduction in stress capital requirements, they are all the same uncertain about evolving regulatory requirements for capital planning.

CECL Requirement 2020

Banks are grappling with new requirements, electric current expected credit losses (CECL) accounting standards and streamlining the CCAR process. CECL integration into CCAR is a top priority in 2020. Ane survey from McKinsey on the qualitative aspect of CCAR revealed that CECL volition be the greatest expanse of focus for 2020 with 28% votes from banks followed past 21% on data quality and 20% on model gamble management. PPNR model development is another prime expanse of focus for 2020. Banks are because potential approaches for CECL integration, with few banks considering a coverage ratio approach.

Brainstorming and lot of thought processes are going around the industry on the handling of CECL in the CCAR framework and on whether this should be considered every bit models or a qualitative arroyo. Banks need to identify the biggest drivers of losses, frame an approach for CECL/CCAR integration, and engage stakeholders across business lines in an iterative way to refine approaches. The CECL model needs to integrate with CCAR considering data needs, production implication, and value impact.

CCAR Automation and Streamlining

Automating CCAR processes is a height priority in the almost future, which will potentially help banks decrease CCAR budget allocations. In one survey conducted by McKinsey, 42% of banks voted in favor of prioritizing automation and streamlining processes, followed by integrating CCAR solution to business as usual and enhancing processes. 48% of banks voted in favor of cutting resources past x%. Banks that accept recently get subject to filing requirements by and large have newer and more interconnected infrastructure.

Interestingly, few banks are at present able to run stress tests in a few hours or days compared to six-plus weeks for some banks. Additionally, banks will proceed work on CCAR governance processes, streamlining committees, and merging activities to reduce wheel times. As part of long-term initiatives, banks will target deject-based workflow solutions that will enable connectivity and a successful run of model components. While automation requires upfront investment, information technology lowers cost in the long run. Banks can focus on higher value-added activities and the CCAR program, optimize portfolios, and appraise potential deals and trades. Banks demand to target high-price areas such every bit running reports, documentation, and handoffs between workstreams.

CCAR Model Adventure Direction

Since models are at the heart of the stress testing plan, model risk direction (MRM) is the most important CCAR control. As role of future improvements, banks accept to emphasize on qualitative model validations, study and enhancement of model limitations, and validating model standards across qualitative and quantitative scenarios. In order to identify and capture model errors early on, institutions will develop model risk management controls across the business, model risk management functions, and audit functions. Banks need to maintain standard models across all modeling teams and accept consummate ownership of their models. Banks need to maintain a well-defined framework for model validation. Framework should include a systematic mode to understand risks and limitations of an individual model. Thus, model validation is of high importance as it detects errors in the process during model use and implications of errors. Therefore, validation teams play a key role here by focusing on testing the source of take a chance (information, framework, performance, governance) rather than following a generic testing plan.

Talent Management

At present that most of the banks have successfully built CCAR mechanism, firms have an opportunity to assess which roles create the highest value and which are no longer required. Institutions should back up talent rotation out of stress testing and then that composition of the CCAR team is proactively managed. From a future perspective, banks will consider opportunities to join multiple disaggregated regulatory teams. Institutions will be able to identify parallel skillsets in multiple parts of the banking company (analytical modeling, scenario development, and review).

Banks should reward people who tin can successfully manage and interact across reporting lines. For instance, they can recognize and reward people who can engage with the consumer retail banking team and the model validation team every bit this helps banks in analyzing the right datasets in modeling.

Banks should prioritize four key areas as mentioned beneath for an effective capital plan, fault-free CCAR models, transparency, and take chances amidst stakeholders and lath members:

• Supervisory engagement and proposing approaches backed by the principle of audio hazard direction
• Balancing uppercase implications and responding to new requirements from FED rationally
• Exploring innovative ways to simplify the CCAR process and focus toward strategy and financial planning
• Optimizing portfolios to the right size of stress upper-case letter and managing uppercase allocation by considering a qualitative and quantitative arroyo

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Source: https://www.hcltech.com/blogs/ccar-comprehensive-capital-analysis-and-review

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