Currently, banks with over $10 billion in assets are required by the FDIC to complete stress testing. If you are part of a community bank or credit union, there are still many benefits to voluntary stress testing. Data suggests that as much as 40% of banks and credit unions already implement stress testing to ensure they are aware of possible portfolio threats. If your institution doesn’t currently have effective stress testing measures in place, consider these four major benefits.
Until you understand the possible risks within your portfolio, you cannot protect your institution. Stress testing shows key stakeholders any risks, shining a light on areas where your financial institution could be vulnerable in a market crash, recession, or other incident.
As an example, consider a credit union that underwrites agricultural loans in the community. If drought conditions were to occur, ruining crops, farmers may be unable to repay loans. If agricultural loans made up 10 percent of the bank’s portfolio, this may not impact financial health. Yet if these loans made up 80 percent of the bank’s portfolio, the institution could fail.
Community banks and credit unions can benefit from accurate, up-to-date data showing information about financial wellness. Yet many small institutions lack the robust software to display such data. By investing in scalable stress testing software, banks can gain access to the sort of data they need to make actionable decisions and protect their best interests.
Going back to the example of the bank making agricultural loans, it’s important that financial institutions actually test areas of risk, once they’ve been identified.
In a stress test, banks can model light, moderate, and severe stress situations to gauge how the institution would be affected. They can see fluctuations in revenue and capital under different modeled scenarios. The stress test can help convince key stakeholders of the bank’s risk by painting a picture of what could happen and how the bank would be affected.
After stress testing, financial institutions should take action to mitigate areas of risk that have been identified through the tests. For example, the lender with an 80 percent agricultural portfolio could diversify their portfolio to reduce their risk. This way, even if a drought affected farm loans, other types of loans could mitigate the losses.
Additionally, community banks that are required to stress test in order to be compliant can use the procedure’s results to implement strategies that foster growth, diversity and volume in areas of higher risks. This process can be used either at the portfolio or individual loan level to guide decision making at the board level. By taking action to reduce risk, small financial institutions can ensure their longevity and success.
CLOUDecision Advanced makes integrating an automated system for stress testing seamless and affordable. With a deep understanding of the challenges faced by today’s community banks, CLOUDecision provides agile, flexible and compliant systems that protect banks, their assets and their data. Request a free trial or demo and discover innovative solutions that are tailored specifically to the financial industry.