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September 15, 2015

Adhering to Dodd Frank Act Supervisory Stress Testing

Post financial crisis US government has enacted an act 'Dodd-Frank wall street reform and consumer protection act. As per this act US bank holding companies with 50$ billion or more in consolidated assets, to conduct an annual stress test. Federal Reserve calculated its projections of a BHC's balance sheet, risk-weighted assets (RWAs), net income, and  resulting regulatory capital ratios under these scenarios using data provided by the BHCs and a set of models developed or selected by the Federal Reserve.

These projections have to be done for nine quarters planning horizon based on three macro economic scenarios (baseline/adverse/severely adverse). It requires banks to calculate

1. PPNR from net interest income, non interest income and non interest expenses
2. Pre-tax net income from PPNR, Revenues, Provisions and Allowance for loan loss
3. After tax income from pre-tax net income and taxes
4. change in equity capital
5. change in regulatory capital

FED projects revenue, expenses and various types of losses and provisions that flow into pre-tax net income based on data provided by Bank Holding Companies with models developed by FED and validated by economists from FED. Banks also have to run their own stress tests with common stress scenarios and assumptions used by FED to help gauge the potential effect of stressful conditions  on the ability of banking institutions to absorb losses while continue to act as credit intermediaries.

BHC's need to compare results of stress tests with scenarios of varying magnitude to improve decision making. Oracle financial services analytical application provides Stress testing as packaged analytical application to achieve all below.

1. Compare results of stress testing across multiple stress scenarios
2. FR Y-14 reporting with projections of PPNR, OTTI, Fair values under different scenarios (FR-Y14 Monthly/Quarterly/Annually)
3. Reporting of OCC DFAST 10-50B results schedule

With all these capabilities OFSAA Stress testing analytics will be an effective enterprise solution to accomplish dynamic regulatory requirements and provides forward looking quantitative evaluation of impacts of stressful economic conditions on BHC capital and capital decision making by management.

OFSAA Analytical application will also enable Bank holding companies to pull out regulatory reports of all magnitude scenarios, quickly respond to emergency business situations and also to cater to evolving regulatory requirements and reporting templates that may get introduced by regulatory bodies.

September 10, 2015

Implementation challenges of CECL Methodology (Current Expected Credit Loss) & leveraging OFSAA LLFP Analytical Solution

In 2012 Financial account standards board (FASB) issued a proposed accounting standard update that proposes that banks and other financial institutions modify recognition of impairment from an "incurred loss" or "probable loss" basis to a "lifetime of loss" estimate. Global financial institutions need to set aside loan impairment reserve for duration of the exposure as opposed to reserving for ''probable losses''. This proposal require banks to calculate loan reserves future loss estimates based on past events, current conditions and reasonable forecasts about the future.

Under this new proposal, though there is no need to determine loan reserve at the loan level it is very important for banks to maintain granular detail throughout the life of the loan. In addition to considering loan attributes, borrower attributes historical loss experience of loan with similar characteristics also need to be considered. Effect of current economic environment as well as projected economic environment arised over the life of the loan.

While implementation of an expected credit loss model require significant work of banks & financial institutions, following are potential challenges to be considered.
a. Complex vintage analysis
b. Data requirements specific to life of loan calculation (LOL)
c. Discounted cash flow analysis
d. Forecastable features(like future drawdowns, delinquency, discount rates, prepayment).

Incorporating CECL method will have significant impact on how banks/financial institutions set aside reserves for future credit losses on impaired assets. In order to address many of these implementation challenges of CECL model Oracle financial services provides packaged solution, OFSAA LLFP which can be leveraged by global banks. LLFP solution provides capability like historical transition matrix , Cohort method for vintage analysis and discounted cash flow methodologies to address these challenges.

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