![]() Within the residential mortgage category, the supervisory loss rate projections from DFAST 2020 materially exceed those generated by internal models for three of the six institutions included in the analysis, while matching the others closely (within a 10 percent range). It is immediately apparent that most of the dots are located substantially above the diagonal line, indicating a systematic tendency for projected loss rates from the supervisory model to exceed those from banks’ internal models.įor the CRE and C&I categories, the supervisory model invariably yields higher loss rates. The diagonal line locates equality between supervisory and bank projections. Įach dot represents an individual institution’s results for one of six loan categories: first-lien residential mortgage credit card other consumer commercial real estate (CRE) commercial and industrial (C&I) and other loans. Cumulative credit loss as a percent of average stress period balance is measured along the vertical axis for the supervisory model and along the horizontal axis for banks’ internal models, for institutions subject to both supervisory and company-run stress tests in the 2020 cycle. A comparison of supervisory versus bank loss rate projections from DFAST 2020, conditional on the Federal Reserve’s severely adverse scenario, is presented in Figure 1. The supervisory models generally yield higher loss rates compared to banks’ internal models, and often these differences are material. SUPERVISORY VERSUS INDUSTRY MODEL RESULTS Another useful step toward greater transparency would be to provide a decomposition of year-to-year changes in loss rates and loss amounts into (1) changes in banks’ portfolios, (2) changes in the severity of supervisory scenarios, and (3) changes in the supervisory models themselves. The reasons for the observed patterns also are not clear. The analysis also characterizes variation in the supervisory projections from year to year. Presumably, public comment might improve the quality of the supervisory models. Moreover, the public could also benefit from more information on elements of conservatism incorporated into the supervisory models. ![]() Additional transparency would improve the efficiency of capital allocation across banks’ business lines by reducing uncertainty around capital requirements and lead to lower management capital buffers. Overall, the discussion highlights a need for greater disclosure and transparency regarding the assumptions of supervisory models. A more likely explanation is that the Federal Reserve applies more conservative assumptions or overlays compared to the banks, although what these might be is not clear. Thus, they seem unlikely to include persistent, material errors. Banks’ models are strictly vetted by examiners from the Federal Reserve and other regulatory agencies and are subject to rigorous validation they are used to make financial projections for public reporting purposes. The analysis demonstrates a systematic tendency for projected loss rates from supervisory models to exceed those from banks’ own internal models. The analysis compares the projected loss rates from the supervisory models to those from banks’ models and to supervisory projections from prior years (2016 through 2019.) In this note, I review loss rate projections for the major consumer and commercial loan segments from the DFAST 2020 regular test. The results from the regular test show that all large banks remain strongly capitalized, and will be used by the Board to set institution-specific stress capital buffer (SCB) requirements under the new capital rule taking effect in the fourth quarter of this year. On June 25, the Federal Reserve Board released the results of its stress tests for 2020 for both the regular, planned stress test initiated prior to the onset of COVID-19 and a supplementary “sensitivity analysis” in response to the evolving conditions.
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