[Federal Register Volume 78, Number 232 (Tuesday, December 3, 2013)]
[Rules and Regulations]
[Pages 72534-72537]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-28608]


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FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 325


Policy Statement on the Principles for Development and 
Distribution of Annual Stress Test Scenarios

AGENCY: Federal Deposit Insurance Corporation.

ACTION: Final guidance.

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SUMMARY: Section 165(i) of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act of 2010 (``Section 165(i)'') requires the 
Federal Deposit Insurance Corporation (the ``FDIC'' or ``Corporation'') 
to issue regulations that mandate FDIC-insured state nonmember banks 
and FDIC-insured state-chartered savings associations with total 
consolidated assets of more than $10 billion (``covered banks'') to 
conduct annual stress tests, report the results of such stress tests to 
the Corporation and the Board of Governors of the Federal Reserve 
System (``Board of Governors''), and publish a summary of the results 
of the stress tests. On October 15, 2012, the FDIC published in the 
Federal Register a final rule implementing the requirements of Section 
165(i) (the ``Stress Test Rule''). Under the Stress Test Rule covered 
banks are required to conduct annual stress tests using a minimum of 
three stress test scenarios (baseline, adverse, and severely adverse) 
provided by the FDIC. On November 20, 2012, the FDIC published in the 
Federal Register interim guidance setting forth the general processes 
and factors to be used by the FDIC in developing and distributing the 
stress test scenarios. The FDIC is now adopting the interim guidance as 
final without change, except for two technical corrections.

DATES:  Effective Date: The final guidance is effective January 2, 
2014.

FOR FURTHER INFORMATION CONTACT: Ryan Sheller, Senior Large Financial 
Institutions Specialist, (202) 412-4861, Division of Risk Management 
and Supervision; Rachel Jones, Attorney, (202) 898-6858, or Grace Pyun, 
Attorney, (202) 898-3609, Legal Division, Federal Deposit Insurance 
Corporation, 550 17th Street NW., Washington, DC 20429.

SUPPLEMENTARY INFORMATION: 

I. Background

    The Dodd-Frank Wall Street Reform and Consumer Protection Act of 
2010 was enacted on July 21, 2010 (the ``Dodd-Frank Act'').\1\ Section 
165(i) of the Dodd-Frank Act requires the FDIC, as a Federal primary 
financial regulatory agency, to issue regulations that mandate covered 
banks to conduct annual stress tests. On October 15, 2012, the FDIC 
issued the Stress Test Rule, which implemented the requirements of 
Section 165(i) and set out definitions and rules for scope of 
application, scenarios, reporting, and disclosure.\2\ Under the Stress 
Test Rule, covered banks are required to conduct annual stress tests 
based on the annual stress test cycle set out in Table 1.
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    \1\ Public Law 111-203, 124 Stat. 1376 (2010).
    \2\ 77 FR 62417 (Oct. 15, 2012).
    \3\ A covered bank that is a subsidiary of a bank holding 
company or a savings and loan holding company may elect to report 
and issue its required public disclosure on its parent bank holding 
company's or savings and loan holding company's timeline.

                 Process Overview of Annual Stress Test
                    [Using data as of September 30th]
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                                                       Timeframe for $10
                                  Timeframe for over    billion to $50
              Step               $50 billion covered    billion covered
                                        banks                banks
------------------------------------------------------------------------
1. FDIC provides covered banks   No later than        No later than
 with scenarios for annual        November 15th.       November 15th.
 stress tests.
2. Covered banks submit          No later than        No later than
 required regulatory reports to   January 5th.         March 31st.\3\
 the FDIC on their stress tests.
3. Covered banks make required   Between March 15th   Between June 15th
 public disclosures.              and March 31st.      and June 30th.
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[[Page 72535]]

    A key component of the annual stress test is the development of the 
stress test scenarios that are provided to covered banks on or before 
November 15th of each year by the FDIC. Scenarios are those sets of 
conditions that affect the U.S. economy or the financial condition of a 
covered bank that the FDIC annually determines are appropriate for use 
in the stress tests, including, but not limited to, baseline, adverse, 
and severely adverse scenarios. Each scenario includes the values of 
the variables specified for each quarter over the stress test horizon. 
The variables specified for each scenario generally address economic 
activity, asset prices, and other measures of financial market 
conditions for the United States and key foreign countries. The FDIC 
annually will determine scenarios that are appropriate for use for each 
annual stress test. The timeline in Table 1 provides that the FDIC will 
distribute stress test scenarios to covered banks no later than 
November 15th of each year.

II. Summary of the Interim Guidance and Comments Received

A. Summary of the Interim Guidance

    The FDIC published interim guidance in the Federal Register on 
November 20, 2012, that articulated the principles the FDIC will apply 
to develop and distribute the stress test scenarios for covered banks 
as required by the Stress Test Rule.\4\ The interim guidance was 
effective immediately and, to the extent practicable, to the 2012 
annual stress test cycle. The FDIC also solicited comment on all 
aspects of the interim guidance for purposes of finalizing the guidance 
and the development and distribution of future stress test scenarios.
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    \4\ 77 FR 69553 (Nov. 20, 2012).
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B. Summary of Comments Received

    The FDIC received two comments on the interim guidance. One comment 
from an individual was not in favor of the Stress Test Rule and 
recommended that the FDIC reconsider finalizing the interim guidance. 
The FDIC believes the interim guidance gives covered banks and the 
market the general processes and factors used for scenario development. 
Furthermore, annual stress tests are necessary because they allow 
covered banks and the FDIC to determine whether those banks have 
capital sufficient to absorb losses that could result from adverse 
economic conditions. The FDIC views stress test results as an important 
source of forward-looking information that can help identify downside 
risks and assess the potential impact of adverse outcomes on capital 
adequacy. Accordingly, the FDIC has decided to finalize this interim 
guidance.
    The other comment from a public interest group supported the 
interim guidance and further recommended that the FDIC include mark-to-
market losses and short-term funding losses in stress test scenarios. 
To that end, the commenter recommended expanding the scenarios to state 
that if mark-to-market losses occur in assets that are funded using 
short-term borrowing (such as asset back commercial paper or repurchase 
agreements), the covered bank must explain what steps (for example 
additional borrowing or asset sales) it would undergo to replace a 
specified percentage of that funding. The FDIC agrees that covered 
banks should consider the subsequent liquidity effects stemming from 
the impact of the stress test scenarios; however, this scenario 
guidance is developed for covered banks under the Stress Test Rule. The 
Stress Test Rule focuses on how well covered banks' capital levels 
withstand hypothetical economic scenarios so that covered banks' 
management can consider the results for conducting capital planning, 
assessing capital adequacy, and evaluating risk management practices. 
The Stress Test Rule does not specifically require covered 
organizations to detail how they would replace short-term funding 
losses. Liquidity stress testing is outside the scope of this guidance, 
however, additional guidance regarding such liquidity stress testing 
may be considered in the future.
    The commenter also recommended that the FDIC disclose additional 
information about the methods and data used in the stress tests. The 
commenter requested that the FDIC disclose the specification, 
statistical fit, or other out-of-sample forecasting properties of the 
risk models that are used for developing the stress test scenarios. The 
FDIC views this guidance as providing useful information to covered 
banks as to how the FDIC develops the economic scenarios including the 
methods and data used for stress testing while maintaining the 
flexibility to establish the underlying methods and data properties of 
risk models for evolving conditions that affect the U.S. economy or the 
financial condition of a covered bank. Accordingly, the Corporation 
does not believe that providing detailed scenario specifications would 
contribute to the broader goal of informing covered banks on the 
development of economic scenarios.
    After reviewing and carefully considering the comments received on 
the interim guidance, the FDIC is finalizing the guidance without 
change, except for two technical corrections.

III. Paperwork Reduction Act

    In accordance with the Paperwork Reduction Act (``PRA'') of 1995 
(44 U.S.C. 3506; 5 CFR Part 1320 Appendix A.1), the FDIC has reviewed 
this final guidance. The FDIC may not conduct or sponsor, and an 
organization is not required to respond to, an information collection 
unless the information collection displays a currently valid OMB 
control number. The FDIC has conducted a PRA analysis on all related 
reporting, recordkeeping and disclosure requirements in the Stress Test 
Rule and submitted them to OMB for review and approval. The request, 
which has been assigned OMB Control No. 3064-0187, has been approved. 
No new collection of information pursuant to the PRA is contained in 
this final guidance. Additionally, the FDIC did not receive any comment 
on the PRA analysis contained in the interim guidance.

IV. Principles for Development and Distribution of Annual Stress Test 
Scenarios

    The text of the final guidance is as follows.

Principles for Development and Distribution of Stress Test Scenarios

I. Introduction

    Section 165(i)(2) of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act of 2010 requires certain financial companies, including 
FDIC-insured state nonmember banks and FDIC-insured state-chartered 
savings associations with total consolidated assets of more than $10 
billion (``covered banks''), to conduct annual stress tests. The 
Federal Deposit Insurance Corporation (``FDIC'' or ``Corporation'') 
published in the Federal Register on October 15, 2012, a final rule 
(``Stress Test Rule'') implementing the requirements and setting out 
definitions and rules for scope of application, scenarios, reporting, 
and disclosure.\1\ Under the Stress Test Rule, each year the FDIC will 
distribute stress test scenarios to covered banks. This document 
articulates the principles that the FDIC will apply to develop and 
distribute those scenarios for covered banks.
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    \1\ 77 FR 62417 (Oct. 15, 2012).
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II. Stress Tests

    As defined by the Stress Test Rule, a stress test means ``the 
process to assess

[[Page 72536]]

the potential impact of scenarios on the consolidated earnings, losses, 
and capital of a covered bank over the planning horizon, taking into 
account the current condition of the covered bank and the covered 
bank's risks, exposures, strategies, and activities.'' \2\ Stress tests 
help covered banks and the FDIC determine whether those banks have 
capital sufficient to absorb losses that could result from adverse 
economic conditions. The FDIC views stress test results as one source 
of forward-looking information that can help identify downside risks 
and assess the potential impact of adverse outcomes on capital 
adequacy. Stress tests are not the only tool the FDIC uses for these 
purposes; a complete assessment of a covered bank's capital position 
typically includes review of its capital planning processes, the 
governance concerning those processes, and the adequacy of capital 
under established regulatory capital measures. The FDIC expects the 
board of directors and senior management of each covered bank to 
consider the results of the annual stress test when conducting capital 
planning, assessing capital adequacy, and evaluating risk management 
practices.\3\ The FDIC also may use stress test results to determine 
whether additional analytical techniques and exercises are appropriate 
for a covered bank to employ in identifying, measuring, and monitoring 
risks to the financial soundness of the covered bank.
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    \2\ 12 CFR 325.202(l).
    \3\ Id. at 325.205(b)(3).
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    Under the Stress Test Rule, each covered bank is required to 
conduct an annual stress test using its financial data as of September 
30th of each year, unless the FDIC requires a different ``as of'' date 
for any or all categories of financial data.\4\ The stress test must 
assess the potential impact of specific scenarios on the regulatory 
capital of the covered bank and on certain related items over a 
forward-looking planning horizon, taking into account all relevant 
exposures and activities.\5\ Under the Stress Test Rule, the planning 
horizon is at least nine quarters, consisting of the fourth quarter of 
the current calendar year plus all four quarters of each of the two 
subsequent calendar years.
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    \4\ Id. at 325.201(c)(2) and 325.203(a).
    \5\ Id. at 325.205(a).
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III. Scenarios

    Scenarios are those sets of conditions that affect the U.S. economy 
or the financial condition of a covered bank that the Corporation 
annually determines are appropriate for use in the stress tests, 
including, but not limited to, baseline, adverse, and severely adverse 
scenarios.\6\ The FDIC annually will determine scenarios that are 
appropriate for use under the Stress Test Rule. In conducting the 
stress test under the Stress Test Rule, each covered bank must use the 
scenarios provided by the FDIC.
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    \6\ Id. at 325.202(i).
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    Each scenario includes the values of the variables specified for 
each quarter over the stress test horizon. The FDIC expects that 
covered banks may not need to use all of the variables provided and may 
need to estimate relationships to identify other variables, such as 
those reflecting local economic conditions, from the values the FDIC 
provides. The FDIC will review the appropriateness of estimation 
processes and resulting estimates, or other modifications of variables, 
through its ongoing supervisory processes.
    The variables specified for each scenario generally address 
economic activity, asset prices, and other measures of financial market 
conditions for the United States and key foreign countries. Variables 
that describe economic activity likely include, but are not limited to, 
the growth rate of gross domestic product, the unemployment rate, and 
the inflation rate. The FDIC anticipates that the path of the 
unemployment rate in particular will be a key variable indicating the 
severity of economic stress, as this variable provides a simple and 
widely noted gauge of the state of the U.S. economy. This point is 
discussed further in this statement in connection with severely adverse 
scenarios.
    Other variables may represent asset prices and financial market 
conditions, including interest rates. The FDIC expects to specify 
scenarios using a standard core set of variables, although variables 
may be added or deleted as the U.S. and global economic environment 
evolves. The FDIC will attempt to minimize additions, redefinitions, or 
re-specifications of the stress test variables from year to year, as 
the use of such new or different variables may potentially require 
covered banks to modify their testing systems.
    The scenarios provided by the FDIC reflect at least three sets of 
economic and financial conditions, described in the rule as baseline, 
adverse, and severely adverse. The baseline broadly corresponds to the 
set of conditions expected to prevail over the term of the stress 
tests. The adverse and severely adverse scenarios introduce 
hypothetical stress conditions intended to test the safety and 
soundness of covered banks as well as their capital planning processes. 
The aim is to assess the covered banks' ability to identify and measure 
the risks they face under adverse conditions, and to ensure that 
appropriate amounts of capital exist to support those risks. The FDIC 
will evaluate both the adequacy of the projections and the processes 
used in the stress test. The FDIC expects covered banks to be able to 
maintain ready access to funding, continue operations, meet obligations 
to creditors and counterparties, and continue to serve as credit 
intermediaries under conditions that are significantly more adverse 
than expected.
    The baseline scenario means a set of conditions that affect the 
U.S. economy or the financial condition of a covered bank, and that 
reflect the consensus views of the economic and financial outlook.\7\ 
These views are based on information obtained from government agencies, 
other public sector organizations, and private sector forecasters as 
close to the date of the annual stress test as possible. The baseline 
may be based on one or more of the ``consensus'' forecasts produced by 
various organizations, although the FDIC may choose to depart from the 
consensus if necessary to provide a more appropriate baseline for the 
stress tests.
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    \7\ Id. at 325.202(c).
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    The adverse scenario means a set of conditions that affect the U.S. 
economy or the financial condition of a covered bank that are more 
adverse than those associated with the baseline scenario and may 
include trading or other additional components.\8\ The adverse scenario 
may also be used to investigate other risks, such as including 
operational risks that the FDIC believes should be better understood or 
more closely monitored.
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    \8\ Id. at 325.202(a).
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    The severely adverse scenario means a set of conditions that affect 
the U.S. economy or the financial condition of a covered bank and that 
overall are more severe than those associated with the adverse scenario 
and may include trading or other additional components.\9\ Three 
examples of severe recessions from recent U.S. experience may 
illustrate the anticipated depth of the severely adverse scenario as it 
relates to the unemployment rate:
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    \9\ Id. at 325.202(j).
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     The 1973-75 recession, during which the unemployment rate 
increased 4.1 percentage points, from 4.9 percent in third quarter 1973 
to 9.0 percent in second quarter 1975 (one quarter after the recession 
ended).

[[Page 72537]]

     The back-to-back recessions in 1980 and 1981-82, during 
which the unemployment rate increased 4.7 percentage points, from 6.1 
percent in fourth quarter 1979 to 10.8 percent in fourth quarter 1982 
(the last quarter of the recession).
     The 2007-09 recession, during which the unemployment rate 
increased 5.3 percentage points, from 4.7 percent in third quarter 2007 
to 10.0 percent in fourth quarter 2009 (two quarters after the 
recession ended).
    Other variables under the adverse and severely adverse scenarios 
would be expected to follow paths consistent with the depth and 
duration of previous recessions and with models of macroeconomic 
activity. The severely adverse scenario also may reflect other risks 
that are especially salient and that might not be captured by past 
recessions, including elevated levels of systemic risk.
    The scenarios distributed by the FDIC for the stress tests will 
cover at least nine quarters. In addition, the FDIC will generally 
publish scenarios that cover one year beyond the planning horizon of 
the stress test, to allow for the estimation of loan losses for the 
year following the stress planning horizon; this additional 
specification allows covered banks to determine adequate levels of loan 
loss reserves.
    The FDIC believes that as a general matter all covered banks should 
use the same set of scenarios and planning horizon so that the FDIC can 
better compare results across covered banks. To that end, the FDIC 
intends to provide one set of scenarios for use by all covered banks. 
However, the FDIC believes there may be circumstances that would 
warrant the use of different or additional scenarios or a planning 
horizon of more than nine quarters. Thus, under the Stress Test Rule, 
the FDIC reserves the authority to require a covered bank to use 
different or additional scenarios and/or planning horizons the 
Corporation may deem appropriate.\10\ For example, a covered bank may 
conduct business activities or have risk exposures that would encounter 
stress under conditions that differ materially from those that would 
generate stress for other banks. The FDIC expects such situations to be 
rare and anticipates making every effort to distribute the same 
scenarios to all covered banks.
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    \10\ Id. at 325.201(c).
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    In addition to the minimum three scenarios, the FDIC may require a 
covered bank with significant trading activities to include factors 
related to trading and counterparty risk in its stress test. Typically, 
these factors might include additional shocks to specific market 
prices, interest rates, rate spreads, or other key market variables 
consistent with historical or hypothetical adverse market events.

IV. Development and Distribution

    As one part of the process of developing scenarios, the FDIC will 
gather information from outside entities and develop themes for the 
stress test scenarios, including the identification of potentially 
material vulnerabilities or salient risks to the financial system, and 
consider potential paths for individual variables. The outside entities 
may include academic experts, staffs of international organizations, 
foreign supervisors, financial institutions that regularly provide 
forecasts, and other private sector risk analysts that regularly 
conduct stress tests based on U.S. and global economic and financial 
scenarios. The FDIC will use the information gathered in this manner to 
inform its consideration of potential risks and scenarios.
    The Office of the Comptroller of the Currency (``OCC''), the Board 
of Governors of the Federal Reserve System (``Board''), and the FDIC 
(collectively, the ``Agencies'') expect to consult closely to develop 
scenarios for stress testing. Absent specific supervisory concerns, the 
FDIC anticipates that the annual stress test scenarios distributed by 
the FDIC will be the same as or nearly identical to the scenarios 
developed by the Board for the supervisory stress tests conducted by 
the Board under Section 165(i)(1). This would mean the same economic 
and financial variables following the same paths as used in the 
scenarios for the Board's supervisory stress tests.
    Although the Agencies generally expect to consult closely on 
scenario development, they may have different views of risks that 
should be reflected in the stress test scenarios used by covered banks 
for the annual stress test. The FDIC may distribute scenarios to 
covered banks that differ in certain respects from those distributed by 
the OCC and the Board if necessary to better reflect specific FDIC 
concerns. The FDIC expects such situations to be extremely rare, 
however, and anticipates making every effort to avoid differences in 
the scenarios required by each agency.
    The FDIC anticipates that the stress test scenarios will be revised 
annually as appropriate to ensure that each scenario remains relevant 
under prevailing economic and industry conditions. These yearly 
revisions will enable the scenarios to capture evolving risks and 
vulnerabilities. The need to ensure that scenarios do not become 
outdated because of economic and financial developments makes a lengthy 
process of review and comment concerning scenarios prior to 
distribution each year impractical. However, the process of 
consultation with the Board and the OCC, as well as the ongoing 
interaction of FDIC staff with public and private sector experts to 
obtain views on salient risks and to obtain suggestions for the 
behavior of key economic variables, should ensure that the stress 
conditions reflected in the scenarios are well suited to their purpose.
    The scenario development process culminates with the distribution 
of the scenarios to all covered banks no later than November 15th of 
each year. The scenario descriptions provided to covered banks will 
include values for economic and financial variables depicting the paths 
those variables follow under the scenarios. The FDIC believes that 
distribution of the scenarios no later than November 15th aligns with 
similar processes at the OCC and the Board.

Federal Deposit Insurance Corporation.

    Dated at Washington, DC, this 25th day of November, 2013.
Robert E. Feldman,
Executive Secretary.
[FR Doc. 2013-28608 Filed 12-2-13; 8:45 am]
BILLING CODE 6714-01-P