The firm had to address several of the regulator’s concerns in a short time frame, and no single consulting firm could do the job, according to people familiar with the matter. The bank hired multiple firms and said it spent about $ 180 million on stress tests during the second half of 2014. The next year, it passed.
The stress tests—designed to determine whether banks can withstand severe economic shocks—have made US banks stronger. Also more robust is the multibillion-dollar industry that has developed around the annual exercise. Last week, the Fed said the 33 largest US banks cleared the first round of stress tests. On Wednesday, the firms will find out which ones can boost dividends or buy back shares.
Globally, banks spent about $ 29 billion on consultants last year, much of that for stress tests in the US and elsewhere, according to analysis firm ALM Intelligence. That compares with $ 16.35 billion in 2007. The total has increased every year since 2009, a period when banks have been relentlessly cutting expenses and employees in areas such as trading and branches.
The Big Four accounting firms and Big Three consulting firms all have built practices offering manpower and advice to pass regulatory muster. Big financial advisers are also in on the act. Last year, BlackRock sold forecasting help to about two-thirds of the banks taking the tests.
There are even consultants offering advice on the most economical use of other stress-test consultants.
“Kick out the consultants,” risk analysis firm Novantas advertised recently, telling banks it can help them cut back.
The industry has sprung up because failing the stress tests, which the Fed made mandatory in their current form in 2011, can have grave consequences. Banks that don’t pass the test can be limited in their ability to raise dividends or buy back shares.
The early versions of the tests helped stem the global financial crisis in 2009 by showing big banks weren’t about to collapse. Since then, both regulators and bankers said the exams have made banks such as Citigroup better able to weather shocks like the British vote to leave the European Union.
One executive said this year’s scenario—which included negative interest rates, along with a 10% unemployment rate and a roughly 50% drop in the stock market—helped catch flaws in systems that weren’t ready to compute rates below zero.
But many question whether the Fed is going overboard. Rob Nichols, president of industry group the American Bankers Association, last week called the tests “unrealistically severe” and “unnecessarily opaque.” The Fed has made the tests harder to pass each year and surprised banks such as Citigroup by flunking them for risk-management practices. Hence, the need for heavy spending each round to adapt to the new versions of the tests.
Banks are expected to quantify precisely how much money they would lose under the scenarios, a herculean task for firms with global footprints, taking hundreds of mathematical models to predict the behaviour of millions of assets. Each loan or investment has unique characteristics a bank must gather, track, check and recheck.
Banks generally underinvested in those skills before 2008, one reason they were hit so hard by the downturn.
The test submissions include a “narrative” document the size of a thick paperback, describing what the firm has done, accompanied by thousands of pages of documentation. Some banks employ professional writers to pen the narratives’ chapters, so the Fed will have fewer questions when it examines the firms.
In all, building a stress-test programme can cost banks $ 150 million to $ 250 million apiece at the start.
Financial firms globally will spend $ 4 billion on stress-test information technology this year, estimates Chartist Research. That is up from $ 3 billion in 2014 and is expected to increase 15% in 2017.
Forecasting models generally range in cost from about $ 100,000 to more than $ 1 million, depending on their complexity.
“We offer customised and off-the-shelf models to help you calculate the stressed probability of defaults,” reads a “Stress Testing Suites” brochure from Moody’s Analytics, a unit of Moody’s.
The banks taking the Fed exams treat stress-test preparation like its own business line, often paying the executives who lead the effort seven-figure salaries.
JP Morgan, the largest US bank by assets, last year had about 550 people working solely on the Fed stress tests, with more than 2,000 employees contributing indirectly, according to a person familiar with the matter.
“It’s like a whole new department at the bank,” said Joe Sullivan, president of International Market Recruiters, which helps banks fill stress-testing jobs.
Stress has become a problem among stress-test employees, who often race to finish the exams before the Fed’s deadline. The night before submissions are due, bank employees have had to stay up loading documents onto the Fed’s slow-moving website, one of many late nights.
The test due date for years was January, notoriously ruining bankers’ year-end holidays. In sympathy, the Fed this year changed the tests’ due date to April, though one banker pointed out that conflicted with spring breaks instead.
Ultimately, the goal is for banks to scale back this mammoth exercise, for executives to have a kind of “push-button” ability to quickly assess their risk, said Michael Alix, who was a senior executive at Bear Stearns during its near-collapse in 2008 and a former Federal Reserve Bank of New York official who now advises banks on the tests as financial services consulting risk leader at PricewaterhouseCoopers.
After the tests are submitted, the Fed comes to question banks about them. Consultants aren’t allowed in the room.
Banks continue to build up their teams.
The posting for a Citigroup job in Mumbai analysing the bank’s risks there and reporting up to the US parent asks for: “Strong attention to detail, willingness to ‘roll up sleeves’ and produce a polished, high quality, accurate product; tireless work ethic with ability to work well under pressure.”
—Emily Glazer and Sarah Krouse contributed to this article.
Write to Ryan Tracy at firstname.lastname@example.org
This article was first published by The Wall Street Journal