Dynamic Stress Testing

“Happy families are all alike; every unhappy family is unhappy in its own way,” reads the opening sentence of Leo Tolstoy’s Anna Karenina.

This is a fitting analogy for stress scenarios. Normal market conditions are generally favorable for everyone, but trouble and unhappiness arise in financial markets in unique and varied ways.

Time and again, over the past 15 years, the largest U.S. banks have proven their ability to withstand severe (hypothetical) shocks, passing the Federal Reserve’s annual stress test with flying colors. While this year was no different, the problem is that the Fed’s so-called CCAR exercise is limited in scope, and has always been more reactive than proactive.

As we saw in 2023, regional banks, just like their larger counterparts, are vulnerable to failure – but they are not currently subject to CCAR. Moreover, whether we’re talking about, say, interest-rate risk, inflation, liquidity risk or commercial real estate hazards, the Fed’s stress scenarios do not typically consider the factors fueling bank fiascoes before they actually happen.

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