Should Small Banks Stress Test? Depends on Who You Ask

Community banks are steeling themselves for stress testing after regulators released results of analysis of the nation's biggest banks.

Executives at small banks are convinced that they will need to conduct stress tests, even though there is nothing in the Dodd-Frank Act requiring them at banks with less than $10 billion of assets. Such concerns were repeatedly aired at last week's annual meeting of the Independent Community Bankers of America in Nashville, Tenn.

The issue was top of mind for Wayne Cottle, the president and chief executive of Dean Co-operative Bank in Franklin, Mass. The $223 million-asset bank is legally exempt, but "ever-increasing regulatory risk management requirements are certainly moving us more and more in that direction," he said in an interview.

Cottle isn't alone. "Community banks feel they are being forced to stress test," said Chris Cole, the ICBA's senior regulatory counsel, noting that the Office of the Comptroller of the Currency is set to release a stress-testing tool for community banks.

The Federal Reserve Board on March 13 released the results of its stress test, with most big banks besting capital requirements. Some bankers involved in that process have projected an eventual trickle-down process that would include smaller banks.

"Trust me, [the regulators] like it because it gives them insight," Kevin Kabat, the president and chief executive of Fifth Third Bancorp, told American Banker in January. "At the end of the day the entire industry will be affected."

At a roundtable during the ICBA conference, representatives from the Fed, OCC and Federal Deposit Insurance Corp. were asked, point-blank, if smaller banks must perform stress tests.

"Notwithstanding what any of the vendors may tell you this week, it's not required," said Kevin Bertsch, associate director of the Fed's division of banking supervision. "That's something we're trying very hard to explain to our examiners."

Several vendors at the conference were pitching products designed to help bankers navigate the regulators process. One of those venders was Andy Greenawalt, the CEO of Continuity Control in New Haven, Conn. He said in an interview that most small banks should stress test even if it isn't required.

Once a bank reaches $500 million in assets, "there really is market change in examination scrutiny," said Greenawalt, who sells compliance-information subscription services. "More bankers should be doing a lot of things to gain a more nuanced understanding of their business, and this is one of those things."

Still, Greenawalt conceded that stress testing is "really overkill" for many banks with less than $250 million in assets. "They see everyone that comes in the door of the bank and they have a really good handle on their loan portfolios," he said.

Bertsch suggested that smaller banks stress test in specific situations. "There is an appropriate use of stress testing there to understand the impact of interest-rate environments on your bank," he said. "We would expect you to do that."

Smaller banks with high concentrations in one loan category, such as commercial real estate, should also consider stress tests. "We want to understand your thinking on how the bank would perform, how your capital position would be affected, if conditions were to take an inverse turn," Bertsch said.

Many community bankers are less worried about capital requirements, and more concerned that they don't have the resources for the complex testing they believe regulators will want, Cole said.

The complex testing conducted at big banks isn't needed at most community banks, Sandra Thompson, the director of the FDIC's division of risk management supervision, said during the roundtable. "We want something very simple and …easy to understand, easy to explain, something that almost anyone in your bank can do," she said. "We're talking Excel spreadsheets or Lotus."

She differentiated between requiring and strongly encouraging stress tests. "We do expect you to take a look at your specific portfolios, especially in this interest-rate environment where interest rates are at record lows," she said. "We just want to be really clear that there is absolutely no tie-in to our expectations for community banks" and what is expected from the largest institutions.

The OCC's tool, set for a summer release, is "just a way to show you one way" of doing stress tests, said Jennifer Kelly, the OCC's senior deputy comptroller for community banks. "It's not a requirement. It's something that we thought would be helpful to your banks."

Some small banks are already stress testing loans, such as the $897 million-asset American Bank Center in Dickinson, N.D. "We stress test all our loans before funding and after they have been funded," Marty Opdahl, the company's chief operating officer, said during an interview at the conference.