Orbit36 interviewed by Risk.net on new stress test for large US banks

Orbit36 managing partner Dr. Andreas Ita had the honour to be surveyed by the world’s leading risk management magazine Risk.net on a new element in the Fed’s 2024 supervisory stress test. The eight major US banks – global firms like JP Morgan, Bank of America or Citigroup – are for this year’s Comprehensive Capital Analysis and Review (CCAR) additionally required to assess the impact from the default of the five hedge funds with the largest counterparty exposure. This as a consequence of the gaps revealed by the collapse of Archegos in March 2021.

The so called Exploratory Analysis is complementary to the Fed’s ordinary 2024 CCAR stress test and the results will only be published in the aggregate. The exercise has no capital implications for the institutions. It’s aim is to deepen the US supervisor’s understanding of the resilience of the overall banking system to a broader range of risks. Next to two hypothetical elements related to funding stress, the large banks have to evaluate the impact from the failure of five hedge funds under two different sets of market shocks.

As I mention in the interview, the additional stress test component is helpful to identify sector-wide vulnerabilities. Some of the market shocks,  e.g. for exchange rates or government bond yields, may be unrealistically large for a day-one shock and could result in extreme results. However, it is important to understand that the main goal of the exercise is not to estimate a realistic stress loss for an individual institution, but to identify hidden counterparty exposures. For this purpose, the approach chosen by the Fed appears powerful.

After the Archegos debacle, Orbit36 has repeatedly pointed out the difficulties for banks and regulators to identify large derivatives counterparty exposures from traditional risk numbers and recommended banks to implement robust stress testing frameworks. We believe that the unconventional approach chosen by the US regulator sets new standards and could be a valuable precedent for banks and supervisors in Europe and Asia.

Please reach out to us if you want to discuss.

Link to article on Risk.net (behind paywall): https://www.risk.net/risk-management/7959033/fed-unveils-hyper-archegos-test-to-reveal-bank-blow-up-risks