Proposed Guidance on Stress Testing for Banking Organizations With More Than $10 Billion in Total Consolidated Assets, 35072-35084 [2011-14777]

Agencies

• FEDERAL DEPOSIT INSURANCE CORPORATION
• FEDERAL RESERVE SYSTEM
• Office of the Comptroller of the Currency
• DEPARTMENT OF THE TREASURY
• Comptroller of the Currency

[Federal Register Volume 76, Number 115 (Wednesday, June 15, 2011)]
[Notices]
[Pages 35072-35084]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-14777]


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DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

[Docket No. OCC-2011-0011]

FEDERAL RESERVE SYSTEM

[Docket No. OP-1421]

FEDERAL DEPOSIT INSURANCE CORPORATION


Proposed Guidance on Stress Testing for Banking Organizations 
With More Than $10 Billion in Total Consolidated Assets

AGENCIES: Office of the Comptroller of the Currency, Treasury 
(``OCC''); Board of Governors of the Federal Reserve System (``Board'' 
or ``Federal Reserve''); Federal Deposit Insurance Corporation 
(``FDIC'').

ACTION: Proposed joint guidance with request for public comment.

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SUMMARY: The OCC, Board, and the FDIC (collectively, the ``agencies'') 
request comment on proposed guidance on stress testing (proposed 
guidance). The proposed joint guidance outlines high-level principles 
for stress testing practices, applicable to all Federal Reserve-
supervised, FDIC-supervised, and OCC-supervised banking organizations 
with more than $10 billion in total consolidated assets. The proposed 
guidance highlights the importance of stress testing as an ongoing risk 
management practice that supports a banking organization's forward-
looking assessment of its risks.

DATES: Comments must be submitted on or before July 29, 2011.

ADDRESSES: OCC: Please use the title ``Proposed Guidance on Stress 
Testing'' to facilitate the organization and distribution of the 
comments. You may submit comments by any of the following methods:
     E-mail: regs.comments@occ.treas.gov.
     Mail: Office of the Comptroller of the Currency, 250 E 
Street, SW., Mail Stop 2-3, Washington, DC 20219.
     Fax: (202) 874-5274.
     Hand Delivery/Courier: 250 E Street, SW., Mail Stop 2-3, 
Washington, DC 20219.
    Instructions: You must include ``OCC'' as the agency name and 
``Docket Number OCC-2011-0011'' in your comment. In general, OCC will 
enter all comments received into the docket and publish them on the 
Regulations.gov Web site without change, including any business or 
personal information that you provide such as name and address

[[Page 35073]]

information, e-mail addresses, or phone numbers. Comments received, 
including attachments and other supporting materials, are part of the 
public record and subject to public disclosure. Do not enclose any 
information in your comment or supporting materials that you consider 
confidential or inappropriate for public disclosure.
    You may review comments and other related materials that pertain to 
this notice by any of the following methods:
     Viewing Comments Personally: You may personally inspect 
and photocopy comments at the OCC, 250 E Street, SW., Washington, DC. 
For security reasons, the OCC requires that visitors make an 
appointment to inspect comments. You may do so by calling (202) 874-
4700. Upon arrival, visitors will be required to present valid 
government-issued photo identification and to submit to security 
screening in order to inspect and photocopy comments.
     Docket: You may also view or request available background 
documents and project summaries using the methods described above.
    Board: When submitting comments, please consider submitting your 
comments by e-mail or fax because paper mail in the Washington, DC area 
and at the Board may be subject to delay. You may submit comments, 
identified by Docket No. OP-1411, by any of the following methods:
     Agency Web Site: https://www.federalreserve.gov. Follow the 
instructions for submitting comments at https://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm.
     Federal eRulemaking Portal: https://www.regulations.gov. Follow the instructions for submitting comments.
     E-mail: regs.comments@federalreserve.gov. Include docket 
number in the subject line of the message.
     Fax: (202) 452-3819 or (202) 452-3102.
     Mail: Jennifer J. Johnson, Secretary, Board of Governors 
of the Federal Reserve System, 20th Street and Constitution Avenue, 
NW., Washington, DC 20551.
    All public comments are available from the Board's Web site at 
https://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as 
submitted, unless modified for technical reasons. Accordingly, your 
comments will not be edited to remove any identifying or contact 
information. Public comments may also be viewed electronically or in 
paper form in Room MP-500 of the Board's Martin Building (20th and C 
Street, NW.,Washington, DC 20551) between 9 a.m. and 5 p.m. on 
weekdays.
    FDIC: You may submit comments by any of the following methods:
     Agency Web site: https://www.FDIC.gov/regulations/laws/federal/propose.html. Follow the instructions for submitting comments.
     Federal eRulemaking Portal: https://www.regulations.gov. 
Follow the instructions for submitting comments.
     E-mail: comments@FDIC.gov. Include ``Stress Testing 
Guidance'' in the subject line of the message. Comments received will 
be posted without change to https://www.FDIC.gov/regulations/laws/federal/propose.html, including any personal information provided.
     Mail: Robert E. Feldman, Executive Secretary, Attention: 
Comments/Legal ESS, Federal Deposit Insurance Corporation, 550 17th 
Street, NW., Washington, DC 20429.
     Hand Delivery/Courier: Guard station at the rear of the 
550 17th Street Building (located on F Street), on business days 
between 7 a.m. and 5 p.m. (EDT).

FOR FURTHER INFORMATION CONTACT: OCC: Robert Scavotto, Lead 
International Expert, International Analysis and Banking Condition 
(202) 874-4943, Tanya Smith, NBE, Basel II Program Manager, Large Bank 
Supervision (202) 874-4464, Akhtarur Siddique, Deputy Director, 
Enterprise Risk Analysis Division (202) 874-4665, or Jeanette Quick, 
Attorney, Legislative and Regulatory Activities Division (202) 874-
5090, Office of the Comptroller of the Currency, 250 E Street, SW., 
Washington, DC 20219.
    Board: Anna Lee Hewko, Assistant Director, Capital and Regulatory 
Policy (202) 530-6260, or Constance M. Horsley, Manager, Capital and 
Regulatory Policy (202) 452-5239, David Palmer, Senior Supervisory 
Analyst, Risk Section, (202) 452-2904, Sviatlana Phelan, Financial 
Analyst, Capital and Regulatory Policy (202) 912-4306, Division of 
Banking Supervision and Regulation; or Benjamin W. McDonough, Counsel, 
(202) 452-2036, or Dominic A. Labitzky, Senior Attorney, (202) 452-
3428, Legal Division, Board of Governors of the Federal Reserve System, 
20th and C Streets, NW., Washington, DC 20551.
    FDIC: George French, Deputy Director, Policy, (202) 898-3929; 
Robert Burns, Chief, Exam Support & Analysis Section, (704) 333-3132 
x4215; Karl Reitz, Senior Capital Markets Specialist, (202) 898-6775, 
Division of Risk Management Supervision; or Mark Flanigan, Counsel, 
(202) 898-7426; Ryan Clougherty, Senior Attorney, (202) 898-3843, 
Supervision Branch, Legal Division.

SUPPLEMENTARY INFORMATION: 

I. Background

    All banking organizations should have the capacity to understand 
their risks and the potential impact of stressful events and 
circumstances on their financial condition.\1\ The U.S. Federal banking 
agencies have previously highlighted the use of stress testing as a 
means to better understand the range of a banking organization's 
potential risk exposures.\2\ The 2007-2009 financial crisis further 
underscored the need for banking organizations to incorporate stress 
testing into their risk management, as banking organizations unprepared 
for stressful events and circumstances can suffer acute threats to 
their financial condition and viability. The proposed guidance is 
intended to be consistent with industry practices and with 
international supervisory standards.\3\
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    \1\ For purposes of this guidance, the term ``banking 
organization'' means national banks and Federal branches and 
agencies supervised by the OCC; state member banks, bank holding 
companies, and all other institutions for which the Federal Reserve 
is the primary Federal supervisor; and state nonmember insured banks 
and other institutions supervised by the FDIC.
    \2\ See, for example, Supervision and Regulation (SR) letter 10-
6 or OCC Bulletin 2010-13 or FDIC FIL-13-2010, ``Interagency Policy 
Statement on Funding and Liquidity Risk Management''; SR 10-1 or OCC 
Bulletin 2010-1 or FDIC Financial Institution Letter (FIL-2-2010), 
``Interagency Advisory on Interest Rate Risk''; SR letter 09-04, 
``Applying Supervisory Guidance and Regulations on the Payment of 
Dividends, Stock Redemptions, and Stock Repurchases at Bank Holding 
Companies''; SR letter 07-1, ``Interagency Guidance on 
Concentrations in Commercial Real Estate'' or OCC Bulletin 2006-46 
or FDIC FIL-104-2006, ``Interagency Guidance on CRE Concentration 
Risk Management''; SR letter 99-18, ``Assessing Capital Adequacy in 
Relation to Risk at Large Banking Organizations and Others with 
Complex Risk Profiles''; OCC Bulletin 2008-20 or FDIC FIL-71-2008 
``Supervisory Guidance: Supervisory Review Process of Capital 
Adequacy (Pillar 2) Related to the Implementation of the Basel II 
Advanced Capital Framework''; the Supervisory Capital Assessment 
Program (see https://www.federalreserve.gov/newsevents/press/bcreg/bcreg20080715a1.pdf); and Comprehensive Capital Analysis and Review: 
Objectives and Overview (see www.federalreserve.gov/newsevents/press/bcreg/20110318a.htm ).
    \3\ See ``Principles for Sound Stress Testing Practices and 
Supervision,'' Basel Committee on Banking Supervision, May 2009.
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    Building upon previously issued supervisory guidance that discusses 
the uses and merits of stress testing in specific areas of risk 
management, the proposed guidance provides an overview of how a banking 
organization should structure its stress testing activities and ensure 
they fit into overall risk management. The purpose of this guidance is 
to outline broad principles for a satisfactory stress testing framework 
and describe the manner in

[[Page 35074]]

which stress testing should be employed as an integral component of 
risk management that is applicable at various levels of aggregation 
within a banking organization, as well as for contributing to capital 
and liquidity planning. While the guidance is not intended to provide 
detailed instructions for conducting stress testing for any particular 
risk or business area, the proposed guidance aims to describe several 
types of stress testing activities and how they may be most 
appropriately used by banking organizations. The guidance does not 
explicitly address the stress testing requirements imposed upon certain 
companies by section 165(i) of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act.\4\ The Board, FDIC, and OCC expect to 
implement that provision in a future rulemaking that would be 
consistent with the principles in the proposed guidance.
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    \4\ Public Law 111-203, 124 Stat. 1376. Section 165(i) of the 
Dodd-Frank Act is codified at 12 U.S.C. 5365(i).
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II. Principal Elements of the Proposed Guidance

    The agencies are issuing this proposed guidance to emphasize the 
importance of stress testing as an ongoing risk management practice 
that supports banking organizations' forward-looking assessment of 
risks and better equips them to address a range of adverse outcomes. 
The proposed joint guidance is applicable to all banking organizations 
supervised by the agencies with more than $10 billion in total 
consolidated assets. Specifically, with respect to the OCC, these 
banking organizations would include national banking associations and 
Federal branches and agencies; with respect to the Board, these banking 
organizations would include state member banks, bank holding companies, 
and all other institutions for which the Federal Reserve is the primary 
Federal supervisor; with respect to the FDIC, these banking 
organizations would include state nonmember insured banks or insured 
branches of foreign banks. A banking organization should develop and 
implement its stress testing framework in a manner commensurate with 
its size, complexity, business activities, and overall risk profile.
    The uses of a banking organization's stress testing framework 
should include, but are not limited to, augmenting risk identification 
and measurement; estimating business line revenues and losses and 
informing business line strategies; identifying vulnerabilities and 
assessing their potential impact; assessing capital adequacy and 
enhancing capital planning; assessing liquidity adequacy and informing 
contingency funding plans; contributing to strategic planning; enabling 
senior management to better integrate strategy, risk management, and 
capital and liquidity planning decisions; and assisting with recovery 
planning.

A. Stress Testing Principles

    Principle 1: A banking organization's stress testing framework 
should include activities and exercises that are tailored to and 
sufficiently capture the banking organization's exposures, activities, 
and risks.
    An effective stress testing framework covers a banking 
organization's full set of material activities, exposures, and risks, 
whether on or off the balance sheet. An effective stress testing 
framework should be applied at various levels in the banking 
organization, such as business line, portfolio, and risk type, as well 
as on an enterprise-wide basis. Each stress test should be tailored to 
the relevant level of aggregation, capturing critical risk drivers, 
internal and external influences, and other key considerations at the 
relevant level. Stress testing should capture the interplay among 
different exposures, activities, and risks and their combined effects. 
Scenarios used in a banking organization's stress tests should be 
relevant to the direction and strategy set by its board of directors.
    Principle 2: An effective stress testing framework employs multiple 
conceptually sound stress testing activities and approaches.
    Banking organizations should use multiple stress testing activities 
and approaches and ensure that each is conceptually sound. Stress tests 
usually vary in design and complexity, including the number of factors 
employed and the degree of stress applied. Effective stress testing 
relies on high-quality input data and information to produce credible 
outcomes. A banking organization should document the assumptions used 
in its stress tests and note the degree of uncertainty that may be 
incorporated into the tools used for stress testing. Furthermore, 
almost all stress tests, including well-developed quantitative tests 
supported by high-quality data, employ a certain amount of expert or 
business judgment that should be made transparent to users of stress 
test results.
    Principle 3: An effective stress testing framework is forward-
looking and flexible.
    A stress testing framework should be sufficiently dynamic and 
flexible to incorporate changes in a banking organization's on- and 
off-balance-sheet activities, portfolio composition, asset quality, 
operating environment, business strategy, and other risks that may 
arise. While stress testing should utilize available historical 
information, a banking organization should look beyond assumptions 
based only on historical data and challenge conventional assumptions. A 
banking organization should carefully consider the incremental and 
cumulative effects of stress conditions. In addition to conducting 
formal, routine stress tests, a banking organization should have the 
flexibility to conduct new or ad hoc stress tests in a timely manner to 
address rapidly emerging risks. A banking organization should continue 
updating and maintaining its stress testing framework in light of new 
risks, better understanding of the banking organization's exposures and 
activities, and any changes in its operating structure and environment.
    Principle 4: Stress test results should be clear, actionable, well 
supported, and inform decision-making.
    Stress testing should incorporate measures that adequately and 
effectively convey the results of its tests. In addition, all stress 
test results should be accompanied by descriptive and qualitative 
information (such as key assumptions and limitations) to allow users to 
interpret the exercises in context. A banking organization should 
regularly communicate stress test results to appropriate levels within 
the banking organization to foster dialogue around stress testing, keep 
management and staff apprised, and to inform stress testing approaches, 
results, and decisions in other areas of the banking organization. In 
addition, management should review stress testing activities on a 
regular basis to determine, among other things, the validity of the 
assumptions, the severity of scenarios and sensitivity tests, the 
robustness of the estimates, the performance of any underlying models, 
and the stability and reasonableness of the results. Finally, stress 
test results should inform a banking organization's analysis and 
decision-making.

B. Stress Testing Approaches and Applications

    The proposed guidance describes certain stress testing approaches 
and applications--scenario analysis, sensitivity analysis, enterprise-
wide testing, and reverse stress testing--that a banking organization 
should strongly consider using within its stress testing framework, as 
appropriate. Each banking organization should apply these approaches 
and applications

[[Page 35075]]

commensurate with its size, complexity, and business profile, and may 
not need to incorporate all of the details described in the proposed 
guidance.
Scenario Analysis
    Scenario analysis refers to a type of stress testing in which a 
banking organization applies historical or hypothetical scenarios to 
assess the impact of various events and circumstances, including 
extreme ones. Scenarios usually involve some kind of coherent, logical 
narrative or ``story'' as to why certain events and circumstances are 
occurring and in which combination and order they occur, such as a 
severe recession, failure of a major counterparty, loss of major 
clients, natural or man-made disaster, localized economic downturn, or 
a sudden change in interest rates brought about by unfavorable 
inflation developments. Stress scenarios should reflect a banking 
organization's unique vulnerabilities to factors that affect its 
exposures, activities, and risks.
Sensitivity Analysis
    Sensitivity analysis refers to a banking organization's assessment 
of its exposures, activities, and risks when certain variables, 
parameters, and inputs are ``stressed'' or ``shocked.'' Generally, 
sensitivity analysis differs from scenario analysis in that it involves 
changing variables, parameters, or inputs without an explicit 
underlying reason or narrative, in order to explore what occurs under a 
range of inputs and at extreme or highly adverse levels. Sensitivity 
analysis can also help to assess the combined impact on a banking 
organization of several variables, parameters, factors, or drivers.
Enterprise-Wide Stress Testing
    Enterprise-wide stress testing involves assessing the impact of 
certain specified scenarios on the banking organization as a whole, 
particularly on capital and liquidity. As is the case with scenario 
analysis more generally, enterprise-wide stress testing involves robust 
scenario design and effective translation of scenarios into measures of 
impact. Enterprise-wide stress tests can help a banking organization in 
its efforts to assess the impact of its full set of risks under adverse 
events and circumstances, but should be supplemented with other stress 
tests and other risk measurement tools given inherent limitations in 
capturing all risks and all adverse outcomes. Selection of scenario 
variables is important for enterprise-wide tests, because they 
generally serve as the link between the overall narrative of the 
scenario and tangible impact on the banking organization as a whole. 
For an enterprise-wide test, assumptions across business lines and risk 
areas should remain constant for the chosen scenario, since the 
objective is to see how the banking organization as a whole responds to 
a common outcome.
Reverse Stress Testing
    Reverse stress testing is a tool that allows a banking organization 
to assume a known adverse outcome, such as suffering a credit loss that 
breaches regulatory capital ratios or suffering severe liquidity 
constraints making it unable to meet its obligations, and then deduce 
the types of events that could lead to such an outcome. This type of 
stress testing may help a banking organization to consider scenarios 
beyond its normal business expectations and see the impact of severe 
systemic effects on the banking organization. It also allows a banking 
organization to challenge common assumptions about its performance and 
expected mitigation strategies. Reverse stress testing helps a banking 
organization evaluate the combined effect of several types of extreme 
events and circumstances that might threaten the survival of the 
banking organization, even if in isolation each of the effects might be 
manageable.

C. Stress Testing for Assessing Adequacy of Capital and Liquidity

    Given the importance of capital and liquidity to a banking 
organization's viability, stress testing should be applied to these two 
areas on a regular basis. Stress testing for capital and liquidity 
adequacy should be conducted in coordination with a banking 
organization's overall strategy and annual and planning cycles. Results 
should be refreshed in the event of major strategic decisions, or other 
decisions that can materially impact capital or liquidity. Banking 
organizations should conduct stress testing for capital and liquidity 
adequacy periodically.
    Capital stress testing supplements a banking organization's 
regulatory capital analysis by providing a forward-looking assessment 
of capital adequacy, usually with a forecast horizon of at least two 
years, and highlighting the potential adverse effects on capital levels 
and ratios of risks not fully captured in regulatory capital 
requirements.\5\ Stress testing can aid capital contingency planning by 
helping management identify exposures or risks that would need to be 
reduced and actions that could be taken to bolster capital levels or 
otherwise maintain capital adequacy, as well as actions that in times 
of stress might not be possible--such as raising capital.
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    \5\ The portions of the proposed guidance that discuss stress 
testing for capital adequacy do not apply to U.S. branches and 
agencies of foreign banking organizations.
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    Using liquidity stress testing, a banking organization can work to 
identify vulnerabilities related to liquidity adequacy in light of both 
firm-specific and market-wide stress events and circumstances.\6\ 
Effective stress testing helps a banking organization identify and 
quantify the depth, source, and degree of potential liquidity strain 
and to analyze possible impacts on its cash flows, liquidity position, 
profitability, and other aspects of its financial condition over 
various time horizons. These tests also help determine whether the 
banking organization has a sufficient liquidity buffer to meet various 
types of future liquidity demands. In this regard, liquidity stress 
testing should be an integral part of the development and maintenance 
of a banking organization's contingency funding planning.
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    \6\ See SR letter 10-6, SR letter 10-1; OCC Bulletin 2010-13, 
OCC Bulletin 2010-1; FDIC FIL 13-2010 and FIL 2-2010.
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    An effective stress testing framework should explore the potential 
for capital and liquidity problems to arise at the same time or 
exacerbate one another. A banking organization's liquidity stress 
analysis should explore situations in which the banking organization 
may be operating with a capital position that exceeds regulatory 
minimums, but is nonetheless viewed within the financial markets or by 
its counterparties as being of questionable viability. For its capital 
and liquidity stress tests, a banking organization should articulate 
clearly its objectives for a post-stress outcome, for instance to 
remain a viable financial market participant that is able to meet its 
existing and prospective obligations and commitments.

D. Governance Over the Stress Testing Framework

    Similar to other aspects of its risk management, a banking 
organization's stress testing framework will be effective only if it is 
subject to strong governance and controls to ensure that the framework 
is functioning as intended. Strong governance and controls also help 
ensure that the framework contains core elements, from clearly defined 
stress testing objectives to recommended actions. Importantly, strong 
governance provides critical review of elements of the stress testing 
framework, especially regarding key

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assumptions, uncertainties, and limitations. A banking organization 
should ensure that the stress testing framework is not isolated within 
a banking organization's risk management function, but is firmly 
integrated into business lines, capital and asset-liability committees, 
and other decision-making bodies.
    The results of stress testing analyses should facilitate decision-
making by the board and senior management. Stress testing results 
should be used to inform the board about alignment of the banking 
organization's risk profile with the board's chosen risk appetite, as 
well as inform operating and strategic decisions. Stress testing 
results should be considered directly by the board and senior 
management for decisions relating to capital and liquidity adequacy. 
The board and senior management should ensure that the stress testing 
framework includes a sufficient range of stress testing activities 
applied at the appropriate levels of the banking organization (i.e., 
not just one enterprise-wide stress test).

III. Request for Comment

    The agencies invite comment on all aspects of the proposed 
guidance. More specifically, what, if any, additional elements or 
aspects of an effective stress testing framework should the agencies 
consider including in this guidance? What additional approaches and 
applications of stress testing have been found to be particularly 
useful aside from those included in the proposed guidance? What 
challenges, if any, exist in applying this guidance generally or at 
particular banking organizations and why? Are there any terms described 
by the proposed guidance that require further clarification and how 
should they be defined?

IV. Administrative Law Matters

A. Paperwork Reduction Act Analysis

    In accordance with the Paperwork Reduction Act (``PRA'') of 1995 
(44 U.S.C. 3506; 5 CFR part 1320 Appendix A.1), the agencies reviewed 
the proposed guidance. The agencies 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 agencies have determined that certain aspects of 
the proposed guidance may constitute a collection of information. In 
particular, these aspects are the provisions that state a banking 
organization should (i) have a stress testing framework that includes 
clearly defined objectives, well-designed scenarios tailored to the 
banking organization's business and risks, well-documented assumptions, 
conceptually sound methodologies to assess potential impact on the 
banking organization's financial condition, informative management 
reports, and recommended actions based on stress test results and (ii) 
have policies and procedures for a stress testing framework. The 
agencies estimate that the above-described information collections 
included in the proposed guidance would take respondents, on average, 
260 hours each year. The frequency of information collection is 
estimated to be annual. Respondents are banking organizations with more 
than $10 billion in total consolidated assets, as defined in the 
guidance:
    OCC:
    Respondents: 50.
    Estimated annual burden: 13,000 hours.
    Board:
    Respondents: 120.
    Estimated annual burden: 31,200 hours.
    FDIC:
    Respondents: 22.
    Estimated annual burden: 5,720 hours.
    OCC: For purposes of the PRA, this information collection will be 
titled Recordkeeping and Disclosure Provisions Associated with Stress 
Testing Guidance.
    This information collection is authorized pursuant to the National 
Bank Act, (12 U.S.C. 1 et seq.; 12 U.S.C. 161) and the International 
Banking Act (12 U.S.C. 3101 et seq.). The OCC expects to review the 
policies and procedures for stress testing as part of its supervisory 
process. To the extent the OCC collects information during an 
examination of a banking organization, confidential treatment may be 
afforded to the records under exemption 8 of the Freedom of Information 
Act (``FOIA''), 5 U.S.C. 552(b)(8). Comments should also be sent to the 
Communications Division, Office of the Comptroller of the Currency, 
Mailstop 2-3, Attention: 1557-NEW, 250 E Street, SW., Washington, DC 
20219. In addition, comments may be sent by fax to (202) 874-5274 or by 
electronic mail to regs.comments@occ.treas.gov. You may personally 
inspect and photocopy comments at the OCC, 250 E Street, SW., 
Washington, DC 20219. For security reasons, the OCC requires that 
visitors make an appointment to inspect comments. You may do so by 
calling (202) 874-4700. Upon arrival, visitors will be required to 
present valid government-issued photo identification and to submit to 
security screening in order to inspect and photocopy comments. 
Additionally, please send a copy of your comments by mail to: OCC Desk 
Officer, 1557-NEW, U.S. Office of Management and Budget, 725 17th 
Street, NW., 10235, Washington, DC 20503, or by fax to (202) 
395-6974. For further information or to request a copy of the OCC's 
collection, please contact Mary H. Gottlieb, OCC Clearance Officer, 
(202) 874-5090, Legislative and Regulatory Activities Division, OCC, 
250 E Street, SW., Washington, DC 20219.
    Board: For purposes of the PRA, this information collection will be 
titled Recordkeeping and Disclosure Provisions Associated with Stress 
Testing Guidance. The agency form number for the collection is FR 4202. 
The agency control number for this new collection will be assigned by 
OMB.
    This information collection is authorized pursuant to sections 
11(a), 11(i), 25, and 25A of the Federal Reserve Act (12 U.S.C. 248(a), 
248(i), 602, and 611), section 5 of the Bank Holding Company Act (12 
U.S.C. 1844), and section 7(c) of the International Banking Act (12 
U.S.C. 3105(c)). The Board expects to review the policies and 
procedures for stress testing as part of the Board's supervisory 
process. To the extent the Board collects information during an 
examination of a banking organization, confidential treatment may be 
afforded to the records under exemption 8 of the Freedom of Information 
Act (``FOIA''), 5 U.S.C. 552(b)(8).
    Comments on the collection of information should be sent to Cynthia 
Ayouch, Acting Federal Reserve Board Clearance Officer, Division of 
Research and Statistics, Mail Stop 95-A, Board of Governors of the 
Federal Reserve System, Washington, DC 20551, with copies of such 
comments sent to the Office of Management and Budget, Paperwork 
Reduction Project (Docket No. OP-1374), Washington, DC 20503.
    Comments are invited on:
    (1) Whether the proposed collection of information is necessary for 
the proper performance of the Federal Reserve's functions, including 
whether the information has practical utility;
    (2) The accuracy of the Federal Reserve's estimate of the burden of 
the proposed information collection, including the cost of compliance;
    (3) Ways to enhance the quality, utility, and clarity of the 
information to be collected; and
    (4) Ways to minimize the burden of information collection on 
respondents, including through the use of automated collection 
techniques or other forms of information technology.

[[Page 35077]]

    FDIC: You may submit comments by any of the following methods:
     Agency Web site: https://www.FDIC.gov/regulations/laws/federal/propose.html. Follow the instructions for submitting comments.
     Federal eRulemaking Portal: https://www.regulations.gov. 
Follow the instructions for submitting comments.
     E-mail: comments@FDIC.gov. Include ``Stress Testing 
Guidance'' in the subject line of the message. Comments received will 
be posted without change to https://www.FDIC.gov/regulations/laws/federal/propose.html, including any personal information provided.
     Mail: Robert E. Feldman, Executive Secretary, Attention: 
Comments/Legal ESS, Federal Deposit Insurance Corporation, 550 17th 
Street, NW., Washington, DC 20429.
     Hand Delivery/Courier: Guard station at the rear of the 
550 17th Street Building (located on F Street), on business days 
between 7 a.m. and 5 p.m. (EDT). Comments are invited on:
    (1) Whether the proposed collection of information is necessary for 
the proper performance of the Federal Reserve's functions, including 
whether the information has practical utility;
    (2) The accuracy of the agencies' estimate of the burden of the 
proposed information collection, including the cost of compliance;
    (3) Ways to enhance the quality, utility, and clarity of the 
information to be collected; and
    (4) Ways to minimize the burden of information collection on 
respondents, including through the use of automated collection 
techniques or other forms of information technology.

B. Regulatory Flexibility Act Analysis

    Board:
    While the guidance is not being adopted as a rule, the Board has 
considered the potential impact of the proposed guidance on small 
banking organizations in accordance with the Regulatory Flexibility Act 
(5 U.S.C. 603(b)). For the reason discussed in the Supplementary 
Information above, the Board is issuing the proposed guidance to 
emphasize the importance of stress testing as an ongoing risk 
management practice to support a banking organization's forward-looking 
assessment of risks in order to better equip such organization to 
address a range of adverse outcomes. The guidance provides an overview 
of how a banking organization should structure its stress testing 
activities to ensure they fit into the organization's overall risk 
management program. The guidance outlines broad principles for a 
satisfactory stress testing framework, and describes the manner in 
which a banking organization should employ stress testing as an 
integral component of risk management. Based on its analysis and for 
the reasons stated below, the Board believes that the proposed guidance 
will not have a significant economic impact on a substantial number of 
small entities. Nevertheless, the Board is publishing an initial 
regulatory flexibility analysis, and seeking comment on whether the 
proposed guidance would impose undue burdens on, or have unintended 
consequences for, small organizations.
    Under regulations issued by the Small Business Administration 
(``SBA''), a small banking organization is defined as a banking 
organization with total assets of $175 million or less. See 13 CFR 
121.201. The guidance being proposed by the Board is intended for 
banking organizations supervised by the agencies with more than $10 
billion in total assets, including state member banks, bank holding 
companies, and U.S. branches and agencies of foreign banking 
organizations. Banking organizations that are subject to the proposed 
guidance therefore substantially exceed the $175 million total asset 
threshold at which a banking organization is considered a small banking 
organization under SBA regulations.
    In light of the foregoing, the Board does not believe that the 
proposed guidance, if adopted in final form, would have a significant 
economic impact on a substantial number of small entities. As noted 
above, the Board specifically seeks comment on whether the proposed 
guidance would impose undue burdens on, or have unintended consequences 
for, small organizations and whether there are ways such potential 
burdens or consequences could be addressed in a manner consistent with 
the guidance.

V. Proposed Guidance

    The text of the proposed guidance is as follows:

Office of the Comptroller of the Currency

Federal Reserve System

Federal Deposit Insurance Corporation

Guidance on Stress Testing for Banking Organizations With Total 
Consolidated Assets of More Than $10 Billion

I. Introduction

    All banking organizations should have the capacity to understand 
fully their risks and the potential impact of stressful events and 
circumstances on their financial condition. The U.S. Federal banking 
agencies have previously highlighted the use of stress testing as a 
means to better understand the range of a banking organization's 
potential risk exposures.\1\ The 2007-2009 financial crisis further 
underscored the need for banking organizations to incorporate stress 
testing into their risk management practices, demonstrating that 
banking organizations unprepared for stressful events and circumstances 
can suffer acute threats to their financial condition and viability.\2\ 
The Federal Reserve, the Office of the Comptroller of the Currency, and 
the Federal Deposit Insurance Corporation (collectively, the 
``agencies'') are issuing this guidance to emphasize the importance of 
stress testing as an ongoing risk management practice that supports 
banking organizations' forward-looking assessment of risks and better 
equips them to address a range of adverse outcomes. This proposed joint 
guidance is applicable to all institutions supervised by the agencies 
with more than $10 billion in total consolidated assets. Specifically, 
with respect to the OCC, these banking organizations would include 
national banking associations and Federal branches and agencies; with 
respect to the Board, these banking organizations would include state 
member banks, bank holding companies, and all other institutions for 
which the Federal Reserve is the primary Federal supervisor; with 
respect to the FDIC, these banking organizations would include state

[[Page 35078]]

nonmember insured banks or insured branches of foreign banks.
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    \1\ See, for example, Supervision and Regulation (SR) letter 10-
6 or OCC Bulletin 2010-13 or FDIC FIL-13-2010, ``Interagency Policy 
Statement on Funding and Liquidity Risk Management''; SR 10-1 or OCC 
Bulletin 2010-1 or FDIC FIL-2-2010, ``Interagency Advisory on 
Interest Rate Risk''; SR letter 09-04, ``Applying Supervisory 
Guidance and Regulations on the Payment of Dividends, Stock 
Redemptions, and Stock Repurchases at Bank Holding Companies''; SR 
letter 07-1, ``Interagency Guidance on Concentrations in Commercial 
Real Estate'' or OCC Bulletin 2006-46 or FDIC FIL-104-2006, 
``Interagency Guidance on CRE Concentration Risk Management''; SR 
letter 99-18, ``Assessing Capital Adequacy in Relation to Risk at 
Large Banking Organizations and Others with Complex Risk Profiles''; 
OCC Bulletin 2008-20 or FDIC FIL-71-2008 ``Supervisory Guidance: 
Supervisory Review Process of Capital Adequacy (Pillar 2) Related to 
the Implementation of the Basel II Advanced Capital Framework''; the 
Supervisory Capital Assessment Program (see https://www.federalreserve.gov/newsevents/press/bcreg/bcreg20080715a1.pdf); 
and Comprehensive Capital Analysis and Review: Objectives and 
Overview (see www.federalreserve.gov/newsevents/press/bcreg/20110318a.htm).
    \2\ Moreover, the Dodd-Frank Wall Street Reform and Consumer 
Protection Act (Pub. L. 111-203, 124 Stat. 1376) requires financial 
organizations with more than $10 billion in total consolidated 
assets to conduct a stress test at least annually. See generally 12 
U.S.C. 5365(i)(2).
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    Building upon previously issued supervisory guidance that discusses 
the uses and merits of stress testing in specific areas of risk 
management, this guidance provides an overview of how a banking 
organization should structure its stress testing activities and ensure 
they fit into overall risk management. The guidance outlines broad 
principles for a satisfactory stress testing framework and describes 
the manner in which stress testing should be employed as an integral 
component of risk management that is applicable at various levels of 
aggregation within a banking organization, as well as for contributing 
to capital and liquidity planning. While the guidance is not intended 
to provide detailed instructions for conducting stress testing for any 
particular risk or business area, the document describes several types 
of stress testing activities and how they may be most appropriately 
used by banking organizations.

II. Overview of Stress Testing Framework

    For purposes of this guidance, stress testing refers to exercises 
used to conduct a forward-looking assessment of the potential impact of 
various adverse events and circumstances on a banking organization. 
Stress testing occurs at various levels of aggregation, including on an 
enterprise-wide basis. As outlined in section IV, there are several 
approaches and applications for stress testing and a banking 
organization should consider the use of each in its stress testing 
framework.
    An effective stress testing framework provides a comprehensive, 
integrated, and forward-looking set of activities for a banking 
organization to employ along with other practices in order to assist in 
the identification and measurement of its material risks and 
vulnerabilities, including those that may only manifest themselves 
during stressful economic or financial environments, or arise from 
firm-specific adverse events. Such a framework should supplement other 
quantitative risk management practices, such as those that rely 
primarily on statistical estimates of risk or loss estimates based on 
historical data, as well as qualitative practices. In this manner, 
stress testing can assist in highlighting unidentified or under-
assessed risk concentrations and interrelationships and their potential 
impact on the banking organization during times of stress.\3\
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    \3\ For purposes of this guidance, the term ``concentrations'' 
refers to groups of exposures and/or activities that have the 
potential to produce losses large enough to bring about a material 
change in a banking organization's risk profile or financial 
condition.
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    A banking organization should develop and implement its stress 
testing framework in a manner commensurate with its size, complexity, 
business activities, and overall risk profile. Its stress testing 
framework should include clearly defined objectives, well-designed 
scenarios tailored to the banking organization's business and risks, 
well-documented assumptions, sound methodologies to assess potential 
impact on the banking organization's financial condition, informative 
management reports, ongoing and effective review of stress testing 
processes, and recommended actions based on stress test results. Stress 
testing should incorporate the use of high-quality data to ensure that 
the outputs are sufficiently credible to support decision-making. 
Importantly, a banking organization should have a sound governance and 
control infrastructure with objective, critical review to ensure the 
stress testing framework is functioning as intended.
    A stress testing framework should allow a banking organization to 
conduct consistent, repeatable exercises that focus on its material 
risks, exposures, activities, and strategies, and also conduct ad hoc 
scenarios as needed. The framework should consider the impact of both 
firm-specific and systemic stress events and circumstances that are 
based on historical experience as well as on hypothetical occurrences 
that could have an adverse impact on a banking organization's 
operations and financial condition. Banking organizations subject to 
this guidance should formally review and assess the effectiveness of 
their stress testing frameworks at least once per year.

III. General Stress Testing Principles

    A banking organization should develop and implement an effective 
stress testing framework as part of its broader risk management and 
governance processes. The framework should include several activities 
and exercises, and not just rely on any single test or type of test, 
since every stress test has limitations and relies on certain 
assumptions.
    The uses of a banking organization's stress testing framework 
should include, but are not limited to, augmenting risk identification 
and measurement; estimating business line revenues and losses and 
informing business line strategies; identifying vulnerabilities and 
assessing their potential impact; assessing capital adequacy and 
enhancing capital planning; assessing liquidity adequacy and informing 
contingency funding plans; contributing to strategic planning; enabling 
senior management to better integrate strategy, risk management, and 
capital and liquidity planning decisions; and assisting with recovery 
planning. This section describes general principles that a banking 
organization should apply in implementing such a framework.
    Principle 1: A banking organization's stress testing framework 
should include activities and exercises that are tailored to and 
sufficiently capture the banking organization's exposures, activities, 
and risks.
    An effective stress testing framework covers a banking 
organization's full set of material activities, exposures, and risks, 
whether on or off the balance sheet. The framework should also address 
non-contractual sources of risks, such as those related to a banking 
organization's reputation. Appropriate coverage is important as stress 
test results could give a false sense of comfort if certain portfolios, 
exposures, or business line activities are not captured. Stress testing 
exercises should be part of a banking organization's regular risk 
identification and measurement activities. For example, in assessing 
credit risk a banking organization should evaluate the potential impact 
of adverse outcomes, such as an economic downturn or declining asset 
values, on the condition of its borrowers and counterparties, and on 
the value of any supporting collateral. As another example, in 
assessing interest-rate risk, banking organizations should analyze the 
effects of significant interest rate shocks or other yield-curve 
movements.
    An effective stress testing framework should be applied at various 
levels in the banking organization, such as business line, portfolio, 
and risk type, as well as on an enterprise-wide basis. In many cases, 
stress testing may be more effective at business line and portfolio 
levels, as a higher level of aggregation may cloud or underestimate the 
potential impact of adverse outcomes on a banking organization's 
financial condition. In some cases, stress testing can also be applied 
to individual exposures or instruments. Each stress test should be 
tailored to the relevant level of aggregation, capturing critical risk 
drivers, internal and external influences, and other key considerations 
at the relevant level.
    Stress testing should capture the interplay among different 
exposures, activities, and risks and their combined

[[Page 35079]]

effects. While stress testing several types of risks or business lines 
simultaneously may prove operationally challenging, a banking 
organization should aim to identify common risk drivers across risk 
types and business lines that can adversely affect its financial 
condition. Accordingly, stress tests should provide a banking 
organization with the ability to identify potential concentrations--
including those that may not be readily observable during benign 
periods and whose sensitivity to a common set of factors is apparent 
only during times of stress--and to assess the impact of identified 
concentrations of exposures, activities, and risks within and across 
portfolios and business lines.
    Stress testing should be tailored to the banking organization's 
idiosyncrasies and specific business mix and include all major business 
lines and significant individual counterparties. For example, a banking 
organization that is geographically concentrated may determine that a 
certain segment of its business may be more adversely affected by 
shocks to economic activity at the state or local level than by a 
severe national recession. On the other hand, if the banking 
organization has significant global operations, it should consider 
scenarios that have an international component and stress conditions 
that could affect the different aspects of its operations in different 
ways, as well as conditions that could adversely affect all of its 
operations at the same time.
    A banking organization should use its stress testing framework to 
determine whether exposures, activities, and risks are aligned with the 
banking organization's risk appetite.\4\ A banking organization can use 
stress testing to help inform decisions about its strategic direction 
and/or risk appetite by better understanding the risks of its exposures 
or of engaging in certain business practices. For example, if a banking 
organization pursues a business strategy for a new or modified product, 
and the banking organization does not have long-standing experience 
with that product or lacks extensive data, the banking organization can 
use stress testing to identify the product's potential downsides and 
unanticipated risks. Scenarios used in a banking organization's stress 
tests should be relevant to the direction and strategy set by its board 
of directors, as well as sufficiently severe to be credible to internal 
and external stakeholders.
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    \4\ For purposes of this guidance, risk appetite is defined as 
the level and type of risk an organization is able and willing to 
assume in its exposures and business activities, given its business 
objectives and obligations to stakeholders. See Senior Supervisors 
Group report, ``Observations on Developments in Risk Appetite 
Frameworks and IT Infrastructure,'' December 2010 (see https://www.newyorkfed.org/newsevents/news/banking/2010/an101223.pdf).
---------------------------------------------------------------------------

    Principle 2: An effective stress testing framework employs multiple 
conceptually sound stress testing activities and approaches.
    All estimates of risk, including stress tests, have an element of 
uncertainty due to assumptions, limitations, and other factors 
associated with using past performance measures and forward-looking 
estimates. Banking organizations should, therefore, use multiple stress 
testing activities and approaches (consistent with section IV), and 
ensure that each is conceptually sound. Stress tests usually vary in 
design and complexity, including the number of factors employed and the 
degree of stress applied. A banking organization should ensure that the 
complexity of any given test does not undermine its integrity, 
usefulness, or clarity. In many cases, relatively simple tests can be 
very useful and informative.
    Additionally, effective stress testing relies on high-quality input 
data and information to produce credible outcomes. A banking 
organization should ensure that it has readily available data and other 
information for the types of stress tests it uses, including key 
variables that drive performance. In addition, a banking organization 
should have appropriate management information systems (MIS) and data 
processes that enable it to collect, sort, aggregate, and update data 
and other information efficiently and reliably within business lines 
and across the banking organization for use in stress testing. If 
certain data and information are not current or not available, a 
banking organization should analyze the stress test outputs with an 
understanding of those data limitations.
    A banking organization should also document the assumptions used in 
its stress tests and note the degree of uncertainty that may be 
incorporated into the tools used for stress testing. In some cases, it 
may be appropriate to present and analyze test results not just in 
terms of point estimates, but also including the potential margin of 
error or statistical uncertainty around the estimates. Furthermore, 
almost all stress tests, including well-developed quantitative tests 
supported by high-quality data, employ a certain amount of expert or 
business judgment; the role and impact of such judgment should be 
clearly documented. In some cases, when credible data are lacking and 
more quantitative tests are operationally challenging or in the early 
stages of development, a banking organization may choose to employ more 
qualitatively based tests, provided that the tests are properly 
documented and their assumptions are transparent. Regardless of the 
type of stress tests used, a banking organization should understand and 
clearly document all assumptions, uncertainties, and limitations, and 
provide that information to users of the stress testing results.
    Principle 3: An effective stress testing framework is forward-
looking and flexible.
    A stress testing framework should be sufficiently dynamic and 
flexible to incorporate changes in a banking organization's on- and 
off-balance-sheet activities, portfolio composition, asset quality, 
operating environment, business strategy, and other risks that may 
arise over time from firm-specific events, macroeconomic and financial 
market developments, or some combination of these events. A banking 
organization should also ensure that its MIS are capable of 
incorporating relatively rapid changes in exposures, activities, and 
risks.
    While stress testing should utilize available historical 
information, a banking organization should look beyond assumptions 
based only on historical data and challenge conventional assumptions. A 
banking organization should ensure that it is not constrained by past 
experience and that it considers a multiple scenarios, even scenarios 
that have not occurred in the recent past or during the banking 
organization's history. For example, a banking organization should not 
assume that if it has suffered no or minimal losses in a certain 
business line or product that such a pattern will continue. Structural 
changes in customer, product, and financial markets can present 
unprecedented situations for a banking organization. A banking 
organization with any type of significant concentration can be 
particularly vulnerable to rapid changes in economic and financial 
conditions and should try to identify and better understand the impact 
of those vulnerabilities in advance. For example, the risks related to 
residential mortgages were underestimated for a number of years by a 
large number of banking organizations, and those risks eventually 
affected the banking organizations in a variety of ways. Effective 
stress testing can help a banking organization identify any such 
concentrations and help understand the potential impact of several key 
aspects of the business being exposed to common drivers.
    Stress testing should be conducted over various relevant time 
horizons to

[[Page 35080]]

adequately capture both conditions that may materialize in the near 
term and adverse situations that take longer to develop. For example, 
when a banking organization stress tests a portfolio for market and 
credit risks simultaneously, it should consider that certain credit 
risk losses may take longer to materialize than market risk losses, and 
also that the severity and speed of mark-to-market losses may create 
significant vulnerabilities for the firm, even if a more fundamental 
analysis of how realized losses may play out over time seems to show 
less threatening results. A banking organization should carefully 
consider the incremental and cumulative effects of stress conditions, 
particularly with respect to potential interactions among exposures, 
activities, and risks and possible second-order or ``knock-on'' 
effects.
    In addition to conducting formal, routine stress tests, a banking 
organization should have the flexibility to conduct new or ad hoc 
stress tests in a timely manner to address rapidly emerging risks. 
These less routine tests usually can be conducted in a short amount of 
time and may be simpler and less extensive than a banking 
organization's more formal, regular tests. However, for its ad hoc 
tests, a banking organization should still have the capacity to bring 
together approximated information on risks, exposures, and activities 
and assess their impact.
    More broadly, a banking organization should continue updating and 
maintaining its stress testing framework in light of new risks, better 
understanding of the banking organization's exposures and activities, 
new stress testing techniques, and any changes in its operating 
structure and environment. A banking organization's stress testing 
development should be iterative, with ongoing adjustments and 
refinements to better calibrate the tests to provide current and 
relevant information. Banking organizations should document the ongoing 
development of their stress testing practices.
    Principle 4: Stress test results should be clear, actionable, well 
supported, and inform decision-making.
    Stress testing should incorporate measures that adequately and 
effectively convey results of the impact of adverse outcomes. Such 
measures may include, for example, changes to asset values, accounting 
and economic profit and loss, revenue streams, liquidity levels, cash 
flows, regulatory capital, risk-weighted assets, loan loss provisions, 
internal capital estimates, levels of problem assets, breaches in 
covenants or key trigger levels, or other relevant measures. Stress 
test measures should be tailored to the type of test and the particular 
level at which the test is applied (for example, at the business line 
or risk level). Some stress tests may require using a range of measures 
to evaluate the full impact of certain events, such as a severe 
systemic event. In addition, all stress test results should be 
accompanied by descriptive and qualitative information (such as key 
assumptions and limitations) to allow users to interpret the exercises 
in context. The analysis and the process should be well documented so 
that stress testing processes can be replicated if need be.
    A banking organization should regularly communicate stress test 
results to appropriate levels within the banking organization to foster 
dialogue around stress testing, to keep the board of directors, 
management, and staff apprised, and to inform stress testing 
approaches, results, and decisions in other areas of the banking 
organization. A banking organization should maintain an internal 
summary of test results to document at a high level the range of its 
stress testing activities and outcomes, as well as proposed follow-up 
actions. In addition, management should review stress testing 
activities on a regular basis to determine, among other things, the 
validity of the assumptions, the severity of tests, the robustness of 
the estimates, the performance of any underlying models, and the 
stability and reasonableness of the results.
    Stress test results should inform analysis and decision-making 
related to business strategies, limits, risk profile, and other aspects 
of risk management, consistent with the banking organization's 
established risk appetite. A banking organization should review the 
results of its various stress tests with the strengths and limitations 
of each test in mind (consistent with Principle 2), determine which 
results should be given greater or lesser weight, analyze the combined 
impact of its tests, and then evaluate potential courses of action 
based on that analysis. A banking organization may decide to maintain 
its current course based on test results; indeed, the results of highly 
severe stress tests need not always indicate that immediate action has 
to be taken. Wherever possible, tools such as benchmarking or other 
comparative analysis should be used to evaluate the stress testing 
results relative to other tools and measures, both internal and 
external to the banking organization, to provide proper context and a 
check on results.

IV. Stress Testing Approaches and Applications

    This section discusses some general types of stress testing 
approaches and applications. For any type of stress test, banking 
organizations should indicate the specific purpose and the focus of the 
test. Defining the scope of a given stress test is also important, 
whether it applies at the portfolio, business line, risk type, or 
enterprise-wide level, or even just for an individual exposure. Based 
on the purpose and scope of the test, different stress testing 
techniques are most useful. Thus, a banking organization should employ 
several stress testing approaches and applications, as needed. Among 
them should be approaches or applications such as scenario analysis, 
sensitivity analysis, enterprise-wide stress testing, and reverse 
stress testing. Consistent with Principle 1, banking organizations 
should apply these commensurate with their size, complexity, and 
business profile, and may not need to incorporate all of the details 
described below. Consistent with Principle 3, banking organizations 
should also recognize that stress testing approaches will evolve over 
time and they should update their practices as needed.

Scenario Analysis

    Scenario analysis refers to a type of stress testing in which a 
banking organization applies historical or hypothetical scenarios to 
assess the impact of various events and circumstances, including 
extreme ones. Scenarios usually involve some kind of coherent, logical 
narrative or ``story'' as to why certain events and circumstances are 
occurring and in which combination and order, such as a severe 
recession, failure of a major counterparty, loss of major clients, 
natural or man-made disaster, localized economic downturn, or a sudden 
change in interest rates brought about by unfavo