United States: Financial Sector Assessment Program-Stress Testing-Technical Notes

EXECUTIVE SUMMARY11. A range of stress tests was used to quantify the potential impacts of risks andvulnerabilities in bank and nonbank sectors. The stress testing exercise reflected a broaderevaluation of potential risks, embodied in the Risk Assessment Matrix (Appendix I). To provide amore comprehensive assessment than possible with any single approach, the stress testing exercisecomprised several approaches. The FSAP team conducted top-down solvency tests for bank holdingcompanies (BHCs) and insurance companies, liquidity risk analysis for BHCs and mutual funds, aswell as market-price based stress tests. Moreover, the exercise was informed by the supervisory(top-down) stress tests performed by the U.S. authorities for the banking sector and the insurancesector, and by company-run (bottom-up) stress tests performed by BHCs. The exercise thus coveredboth banks and nonbanks (including insurance companies and mutual funds). It encompassedsolvency and liquidity risks, as well as contagion risks. In the case of BHCs, the tests performed byIMF staff complement the Dodd-Frank Act stress test (DFAST) results.2. The stress tests run by the authorities and by companies under the DFA suggest thatmost large BHCs are resilient to shocks similar to the last crisis. The DFA requires the FRB toconduct an annual supervisory stress test of BHCs with total consolidated assets of $50 billion ormore. It also requires all financial institutions with total consolidated assets of more than $10 billionto conduct company-run stress tests at least once a year. The results of the 2015 supervisory andcompany run stress tests, released in March, suggest that the system is resilient to severe shocks.Even in the severely adverse scenario (resembling the 2008–09 crisis), all the 31 BHCs have sufficientcapital to absorb losses, which is the first time since the start of annual stress tests in 2009 that nofirm fell below any of the main capital thresholds. The tests do not cover insurance and othernonbank financial institutions and do not capture network effects or analyze liquidity risks.3. The staff's analysis benefitted from the relatively wide range of publicly available data,but was nonetheless subject to data constraints. Due to constraints on the authorities' ability toshare confidential supervisory information with the team, the analysis relied largely on publiclyavailable data. The public data gathered was very extensive, but had notable gaps in some areas. Forexample, a lack of security-level granularity in publicly available data made full-fledged liquiditystress testing for BHCs and mutual funds a challenge. Data on interconnectedness among financialinstitutions have important gaps, although the authorities assisted the team in performing acontagion stress test for a sample of large BHCs. The insurance sector analysis was also constrained by valuation practices in the United States, complexity of the insurance business and its regulation,and the absence of group-level risk-based capital.