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 portfolios. Given 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.