[Federal Register Volume 78, Number 208 (Monday, October 28, 2013)]
[Rules and Regulations]
[Pages 64153-64156]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-25421]


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DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Part 46

[Docket No. OCC-2012-0016]


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

AGENCY: Office of the Comptroller of the Currency, Treasury (OCC).

ACTION: Final guidance.

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SUMMARY: This final guidance sets forth the general processes and 
factors to be used by the OCC in developing and distributing the stress 
test scenarios for the annual stress test required by the Dodd-Frank 
Wall Street Reform and Consumer Protection Act of 2010 (``Dodd-Frank 
Act'') as implemented by the Annual Stress Test final rule (Stress Test 
Rule) published on October 9, 2012. Under the Stress Test Rule national 
banks and federal savings associations with total consolidated assets 
of more than $10 billion (covered institutions) are required to conduct 
annual stress tests using a minimum of three scenarios (baseline, 
adverse and severely adverse) provided by the OCC. The Stress Test Rule 
specified that the OCC will provide the required scenarios to the 
covered institutions by November 15th of each year. On November 15, 
2012, the OCC published interim guidance explaining how the OCC would 
develop the stress test scenarios.\1\ The OCC is now adopting the 
interim guidance as final.
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    \1\ 77 FR 68047 (November 15, 2012).

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DATES: This final guidance is effective November 27, 2013.

FOR FURTHER INFORMATION CONTACT: Robert Scavotto, Deputy Director, 
International Analysis and Banking Condition (202) 649-5477, Richard 
Nisenson, Director, Industry and Regional Analysis (202) 649-5457, 
Henry Barkhausen, Attorney, or Ron Shimabukuro, Senior Counsel, 
Legislative and Regulatory Activities Division (202) 649-5490, Office 
of the Comptroller of the Currency, 400 7th St. SW., Washington, DC 
20219.

SUPPLEMENTARY INFORMATION: 

I. Background

    Section 165(i)(2) of the Dodd-Frank Act requires certain financial 
companies, including national banks and federal savings associations 
with total consolidated assets of more than $10 billion (covered 
institutions), to conduct annual stress tests. The OCC published in the 
Federal Register on October 9, 2012, the final Stress Test Rule \2\ 
implementing the requirements and setting out definitions and rules for 
scope of application, scenarios, reporting, and disclosure. Under the 
Stress Test Rule, covered institutions are required to conduct annual 
stress tests based on the annual stress test cycle set out in Table 1.
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    \2\ 77 FR 61238 (October 9, 2012).

   Table 1--Process Overview of Annual Stress Test Cycles for Covered
                              Institutions
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                                                           $10 to $50
             Key step               Over $50 billion        billion
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1. OCC distributes scenarios for   By November 15....  By November 15.
 annual stress tests.
2. Covered institutions conduct    By January 5......  By March 31.
 annual stress test and submit
 Annual Stress Test Report to the
 OCC and the Board.
3. Covered institutions make       Between March 15    Between June 15
 required public disclosures.       and March 31.       and June 30.
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[[Page 64154]]

    A key component of the annual stress test is the stress test 
scenarios. Scenarios are sets of conditions that affect the U.S. 
economy or the financial condition of covered institutions. 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 OCC annually will determine scenarios that are 
appropriate for use for each annual stress test. The timeline in Table 
1 provides that the OCC will distribute stress test scenarios to 
covered institutions by November 15th of each year. This document 
articulates the principles that the OCC will apply to develop and 
distribute those scenarios for covered institutions.

II. Summary of Comment Received

    The OCC published interim guidance in the Federal Register on 
November 15, 2012, that explained the principles the OCC will apply to 
develop stress test scenarios. The interim guidance was effective 
immediately. The OCC solicited comment on all aspects of the interim 
guidance and received one comment on the interim guidance. A public 
interest group believed that stress test scenarios should factor in the 
possible loss of short-term funding. The OCC agrees with the commenter 
that short-term funding and liquidity in general are factors that need 
to be considered. In this regard the OCC notes that the final guidance, 
while focusing on the capital position of covered institutions, would 
permit the use of interagency scenarios that include contraction in 
short-term funding, if appropriate. Additionally, the interagency 
Supervisory Guidance on Stress Testing for Banking Organizations With 
More than $10 Billion in Total Consolidated Assets, which applies to 
all stress testing and not merely stress testing pursuant to the Stress 
Test Rule, specifically requires that stress tests take into account 
liquidity. (``[U]ses of a banking organization's stress testing 
framework should include . . . assessing liquidity adequacy and 
informing contingency funding plans.'') \3\ Finally, the OCC is working 
with the Federal Reserve Board and the Federal Deposit Insurance 
Corporation on rules to implement the Basel III liquidity 
provisions.\4\
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    \3\ 77 FR 29458, 29465 (May 17, 2012).
    \4\ Regulatory Capital, Implementation of Basel III, Minimum 
Regulatory Capital Ratios, Capital Adequacy, Transition Provisions, 
and Prompt Corrective Action, 77 FR 52792, 52796, n.11 (Aug. 30, 
2012).
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    The commenter also believed that stress testing models should be 
made publicly available so that they can be subject to ``open source'' 
critique. The commenter believed that ``[t]here are no requirements 
that the federal regulators or the covered banks discuss the 
specification, statistical fit, or out-of-sample forecasting properties 
of the risk models they are using.'' The commenter requests disclosure 
of both supervisory models and the stress testing models used by 
covered institutions. The first part of the request is not applicable 
to the OCC because the OCC is not required by the Dodd-Frank Act to run 
supervisory models. The second part of the request would require an 
amendment to the Stress Test Rule and is outside the scope of this 
guidance, which addresses the process for developing the baseline, 
adverse, and severely adverse stress test scenarios. While the 
scenarios are key inputs for the company-run and supervisory stress 
test models, the scenarios are different from the models themselves. 
The OCC does, as part of the supervisory process, however, expect 
covered institutions to have a stress testing framework that 
incorporates validation or other type of independent review aimed at 
ensuring the integrity of stress testing processes and results.\5\ If a 
banking organization engages a third-party vendor to support some or 
all of its stress testing activities, there should be appropriate 
controls in place to ensure that those externally developed systems and 
processes are sound, applied correctly, and appropriate for the banking 
organization's risks, activities, and exposures.\6\
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    \5\ For validation of models and other quantitative tools used 
for stress testing, see OCC Bulletin 2011-12, ``Supervisory Guidance 
on Model Risk Management,'' April 4, 2011, available at http://www.occ.gov/news-issuances/bulletins/2011/bulletin-2011-12a.pdf.
    \6\ 77 FR 29458, 29471 (May 17, 2012).
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III. Paperwork Reduction Act

    In accordance with the Paperwork Reduction Act (PRA) of 1995 (44 
U.S.C. 3506; 5 CFR Part 1320, Appendix A1), the OCC reviewed the final 
guidance. The OCC 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 Office of Management 
and Budget (OMB) control number. The final guidance contains no new 
collections of information under the PRA beyond those contained in OMB 
Control No. 1557-0311, the collection covering the Stress Test Rule.

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

    The text of the guidance is as follows.

Principles for Development and Distribution of Annual 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 
national banks and federal savings associations with total consolidated 
assets of more than $10 billion (covered institutions), to conduct 
annual stress tests. The Office of the Comptroller of the Currency 
(OCC) published in the Federal Register on October 9, 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 OCC will 
distribute stress test scenarios to covered institutions. This document 
articulates the principles that the OCC will apply to develop and 
distribute those scenarios for covered institutions.
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    \1\ Annual Stress Test, 77 FR 61238 (October 9, 2012).
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II. Stress Tests

    As defined by the Stress Test Rule, a stress test is ``a process to 
assess the potential impact of stressful scenarios on the consolidated 
earnings, losses, and capital of a covered institution over the 
planning horizon, taking into account the covered institution's current 
condition, risks, exposures, strategies, and activities.'' \2\
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    \2\ 12 CFR 46.2 (Definition of Stress Test).
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    Stress tests help covered institutions and the OCC determine 
whether those institutions have capital sufficient to absorb losses 
that could result from adverse economic conditions. The OCC 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 OCC uses for these purposes; a complete assessment of a 
covered institution's capital position typically includes a review of 
its capital planning processes, the governance concerning those 
processes, and the adequacy of capital under established regulatory 
capital measures. The OCC expects the board of directors and senior 
management of each covered institution to consider the results of the 
annual stress test when

[[Page 64155]]

conducting capital planning, assessing capital adequacy, and evaluating 
risk management practices. The OCC also may use stress test results to 
determine whether additional analytical techniques and exercises are 
appropriate for a covered institution to employ in identifying, 
measuring, and monitoring risks to the financial soundness of the 
covered institution.
    Under the Stress Test Rule, each covered institution is required to 
conduct an annual stress test using its financial data as of September 
30 of each year, unless the OCC requires a different ``as of'' date for 
any or all categories of financial data. The stress test must assess 
the potential impact of specific scenarios on the regulatory capital of 
the covered institution and on certain related items over a forward-
looking planning horizon, taking into account all relevant exposures 
and activities.\3\ 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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    \3\ Id. at 46.6(a).
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III. Scenarios

    Scenarios are sets of conditions that affect the U.S. economy or 
the financial condition of covered institutions.\4\ The OCC 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 institution must use the scenarios provided by the OCC.
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    \4\ Id. at 46.2 (Definition of scenarios).
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    Each scenario includes the values of the variables specified for 
each quarter over the stress test horizon. The OCC expects that covered 
institutions 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 OCC 
provides. The OCC 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 will include, but not be limited 
to, the growth rate of gross domestic product, the unemployment rate, 
and the inflation rate. The OCC anticipates that the path (which 
reflects the level and rate of change) of the unemployment rate during 
the planning horizon 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 OCC expects to specify 
scenarios using a fairly stable core set of variables, although 
variables may be added or deleted as the U.S. and global economic 
environment evolves. The OCC will attempt to minimize additions, 
redefinitions, or re-specifications from year to year, recognizing that 
the use of new or modified variables for stress tests may require 
potentially costly systems changes at covered institutions.
    The scenarios provided by the OCC 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 institutions as well as their capital planning 
processes. The aim is to assess the ability of covered institutions 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 OCC will evaluate both the adequacy of the projections and 
the processes used in the company-run stress tests. The OCC expects 
covered institutions 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 establishes a benchmark set of conditions 
that incorporates the most current views on the macroeconomic outlook. 
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 OCC may choose to depart from the 
consensus if necessary to provide a more appropriate baseline for the 
stress tests.
    The adverse scenario is a hypothetical set of conditions designed 
to simulate a moderate level of stress that covered companies could 
experience, such as a mild-to-moderate U.S. recession. The adverse 
scenario may also be used to investigate other risks, perhaps including 
operational risks, that the OCC believes should be better understood or 
more closely monitored.
    The severely adverse scenario is a set of quite challenging 
economic and financial conditions, such as those that might be 
experienced in a relatively severe recession. 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:
     The 1973-75 recession, during which the unemployment rate 
increased 4.1 percentage points, from 4.9 percent in 1973Q3 to 9.0 
percent in 1975Q2 (one quarter after the recession ended).
     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 1979Q4 to 10.8 percent in 1982Q4 (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 2007Q3 to 10.0 
percent in 2009Q4 (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 OCC for the stress tests cover at 
least nine quarters. In addition, the OCC 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 institutions to determine adequate levels of loan loss 
reserves.
    The OCC believes that as a general matter all covered institutions 
should use the same set of scenarios and planning horizon so that the 
OCC can better compare results across institutions. To that end, the 
OCC intends to provide one set of scenarios for use by all covered 
institutions. However, the OCC believes there may be

[[Page 64156]]

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 OCC reserves the authority to require a 
covered institution to use different or additional scenarios and/or 
planning horizons the agency may deem appropriate. For example, a 
covered institution 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 
institutions. The OCC expects such situations to be rare and 
anticipates making every effort to distribute the same scenarios to all 
covered institutions.
    In addition to the minimum three scenarios, the OCC may require a 
covered institution 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 OCC 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 OCC will use the information gathered in this manner to 
inform its consideration of potential risks and scenarios.
    The OCC, the Board of Governors of the Federal Reserve System 
(Board), and the Federal Deposit Insurance Corporation (FDIC) 
(Agencies) expect to consult closely to develop scenarios for stress 
testing. Absent specific supervisory concerns, the OCC anticipates that 
the annual stress test scenarios distributed by the OCC 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 
institutions for the annual stress test. The OCC may distribute 
scenarios to covered institutions that differ in certain respects from 
those distributed by the FDIC and the Board if necessary to better 
reflect specific OCC concerns. The OCC expects such situations to be 
extremely rare, however, and anticipates making every effort to avoid 
differences in the scenarios required by each agency.
    The OCC 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 FDIC, as well as the ongoing 
interaction of OCC 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 institutions no later than November 15 
of each year. The scenario descriptions provided to covered 
institutions will include values for economic and financial variables 
depicting the paths those variables follow under the scenarios. The OCC 
believes that distribution of the scenarios by November 15 aligns with 
similar processes at the FDIC and the Board.

    Dated: October 21, 2013.
Thomas J. Curry,
Comptroller of the Currency.
[FR Doc. 2013-25421 Filed 10-25-13; 8:45 am]
BILLING CODE 4810-33-P