New paper proposes ‘better’ approach to stress-testing bank assets

Under the proposed Dodd-Frank Wall Street Reform and Consumer Protection Act, banks with more than $10 billion in assets may be required to conduct annual stress tests on their loan portfoliosGiven the current credit environment and increased pressure from regulatory authorities, even banks with assets under $10 billion—as well as insurance companies—are considering implementing systematic stress-testing programs, says a new white paper by DebtX, “Stress Testing and Fair Market Value: Increased Transparency for Risk Management and Regulatory Examinations.”

“By estimating each loan’s market price under a variety of market conditions, lenders can improve upon stress-testing methodologies that rely on collateral values, indirect measures or undisclosed valuation techniques,” says the introduction. To illustrate its valuation methodology, the DebtX paper also presents two mark-to-market stress-testing scenarios that use loan-by-loan valuations based on loan sale trade data.